AUSES OF THE

CONOMIC

RISIS

THER

SSAYS

EFORE

AND

FTER THE

REAT

EPRESSION

UDWIG VON

ISES

The Ludwig von Mises Institute

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AUSES OF THE

CONOMIC

RISIS

THER

SSAYS

EFORE

AND

FTER THE

REAT

EPRESSION

Edited by Percy L. Greaves, Jr.

UDWIG VON

ISES

Ludwig
von Mises
Institute

AUBURN, ALABAMA

On the Manipulation of Money and Credit © 1978 by Liberty Fund, Inc.
Reprinted by permission.

Originally published as On the Manipulation of Money and Credit in 1978
by Free Market Books.

Translated from the original German by Bettina Bien Greaves and Percy L.
Greaves, Jr.

The Mises Institute would like to thank Bettina Bien Greaves for her sup-
port and interest in this new edition.

Foreword and new material copyright © 2006 by the Ludwig von Mises
Institute.

All rights reserved. No part of this book may be reproduced in any manner
whatsoever without written permission except in the case of quotes in the
context of reviews. For information write the Ludwig von Mises Institute,
518 West Magnolia Avenue, Auburn, Alabama 36832; www.mises.org.

ISBN: 1-933550-03-1
ISBN: 978-1-933550-03-9

ONTENTS

OREWORD

by Frank Shostak....................................................................xi

NTRODUCTION

by Percy L. Greaves, Jr. ............................................ xiii

HAPTER

1—S

TABILIZATION OF THE

ONETARY

NIT

—F

ROM THE

IEWPOINT OF

HEORY

(1923) ....................................1

I. The Outcome of Inflation ............................................................2

1. Monetary Depreciation ............................................................2

2. Undesired Consequences ........................................................6

3. Effect on Interest Rates ............................................................7

4. The Run from Money ..............................................................8

5. Effect of Speculation ................................................................9

6. Final Phases ..............................................................................10

7. Greater Importance of Money to a Modern Economy ..12

II. The Emancipation of Monetary Value

From the Influence of Government ........................................14

1. Stop Presses and Credit Expansion ....................................14

2. Relationship of Monetary Unit to World Money

—Gold........................................................................................15

3. Trend of Depreciation ............................................................16

III. The Return to Gold ....................................................................18

1. Eminence of Gold ....................................................................18

2. Sufficiency of Available Gold ................................................19

IV. The Money Relation ....................................................................21

1. Victory and Inflation ..............................................................21

2. Establishing Gold “Ratio” ......................................................22

V. Comments on the “Balance of Payments” Doctrine ..........25

1. Refined Quantity Theory of Money ....................................25

vi — The Causes of the Economic Crisis

2. Purchasing Power Parity ..................................................26

3. Foreign Exchange Rates ..................................................27

4. Foreign Exchange Regulations ......................................29

VI. The Inflationist Argument ..................................................31

1. Substitute for Taxes ..........................................................31

2. Financing Unpopular Expenditures ..............................32

3. War Reparations................................................................34

4. The Alternatives ................................................................35

5. The Government’s Dilemma ..........................................37

VII. The New Monetary System ................................................39

1. First Steps ..........................................................................39

2. Market Interest Rates ......................................................41

VIII. The Ideological Meaning of Reform ..................................43

1. The Ideological Conflict..................................................43

Appendix: Balance of Payments and Foreign

Exchange Rates ..................................................................44

HAPTER

2—M

ONETARY

TABILIZATION AND

YCLICAL

OLICY

(1928) ............................................................................53

Stabilization of the Purchasing Power of
the Monetary Unit

........................................................................57

I. The Problem ............................................................................57

1. “Stable Value” Money ......................................................57

2. Recent Proposals ..............................................................58

II. The Gold Standard..................................................................60

1. The Demand for Money..................................................60

2. Economizing on Money ..................................................62

3. Interest on “Idle” Reserves ..............................................65

4. Gold Still Money ..............................................................67

III. The “Manipulation of the Gold Standard” ......................68

1. Monetary Policy and Purchasing Power of Gold ......68

2. Changes in Purchasing Power of Gold ........................71

IV. “Measuring” Changes in the Purchasing

Power of the Monetary Unit ................................................73

1. Imaginary Constructions ................................................73

2. Index Numbers..................................................................77

V. Fisher’s Stabilization Plan ......................................................80

1. Political Problem ..............................................................80

2. Multiple Commodity Standard ......................................81

3. Price Premium ..................................................................82

4. Changes in Wealth and Income ....................................85

5. Uncompensatable Changes ............................................86

VI. Goods-Induced and Cash-Induced Changes in the

Purchasing Power of the Monetary Unit ..........................88

1. The Inherent Instability of Market Ratios ..................88

2. The Misplaced Partiality to Debtors ............................91

VII. The Goal of Monetary Policy ..............................................93

1. Liberalism and the Gold Standard ................................93

2. “Pure” Gold Standard Disregarded ..............................94

3. The Index Standard ..........................................................96

Cyclical Policy to Eliminate Economic Fluctuations

................97

I. Stabilization of the Purchasing Power

of the Monetary Unit and Elimination
of the Trade Cycle ............................................................97

1. Currency School’s Contribution ....................................97

2. Early Trade Cycle Theories ............................................99

3. The Circulation Credit Theory....................................101

II. Circulation Credit Theory ..................................................103

1. The Banking School Fallacy ........................................103

2. Early Effects of Credit Expansion ......................................

3. Inevitable Effects of Credit Expansion

on Interest Rates ............................................................105

4. The Price Premium ........................................................109

5. Malinvestment of Available Capital

Goods ................................................................................109

Contents — vii

6. “Forced Savings”..............................................................111

7. A Habit-forming Policy ................................................113

8. The Inevitable Crisis and Cycle ..................................113

III. The Reappearance of Cycles ..............................................116

1. Metallic Standard Fluctuations....................................116

2. Infrequent Recurrences of Paper Money

Inflations ..........................................................................117

3. The Cyclical Process of Credit Expansions ..............119

4. The Mania for Lower Interest Rates ..........................121

5. Free Banking ....................................................................124

6. Government Intervention in Banking........................125

7. Intervention No Remedy ..............................................127

IV. The Crisis Policy of the Currency School ......................128

1. The Inadequacy of the Currency School ..................128

2. “Booms” Favored ............................................................130

V. Modern Cyclical Policy ........................................................132

1. Pre-World War I Policy ................................................132

2. Post-World War I Policies ............................................133

3. Empirical Studies ............................................................135

4. Arbitrary Political Decisions ........................................136

5. Sound Theory Essential ................................................138

VI. Control of the Money Market ............................................140

1. International Competition or Cooperation ..............140

2. “Boom” Promotion Problems ......................................142

3. Drive for Tighter Controls ............................................144

VII. Business Forecasting for Cyclical Policy and the

Businessman ..........................................................................146

1. Contributions of Business Cycle

Research............................................................................146

2. Difficulties of Precise Prediction ................................148

VIII. The Aims and Method Cyclical Policy ............................149

1. Revised Currency School Theory ..............................149

viii — The Causes of the Economic Crisis

2. “Price Level” Stabilization ............................................151

3. International Complications ........................................152

4. The Future........................................................................153

3—T

AUSES OF THE

CONOMIC

RISIS

(1931) ............................155

I. The Nature and Role of the Market ....................................155

1. The Marxian “Anarchy of Production” Myth ..........155

2. The Role and Rule of Consumers ..............................156

3. Production for Consumption......................................157

4. The Perniciousness of a “Producers’ Policy” ..........159

II. Cyclical Changes in Business Conditions ..........................160

1. Role of Interest Rates ....................................................160

2. The Sequel of Credit Expansion ................................162

III. The Present Crisis ....................................................................163

Unemployment

......................................................................164

1. The Market Wage Rate Process..................................164

2. The Labor Union Wage Rate Concept......................166

3. The Cause of Unemployment ....................................167

4. The Remedy for Mass Unemployment ....................168

5. The Effects of Government Intervention ................169

6. The Process of Progress ..............................................171

B. Price Declines and Price Supports ....................................172

1. The Subsidization of Surpluses ..................................172

2. The Need for Readjustments ......................................173

Tax Policy

..............................................................................174

1. The Anti-Capitalistic Mentality ................................174

Gold Production

..................................................................176

1. The Decline in Prices....................................................176

2. Inflation as a “Remedy” ................................................178

IV. Is There a Way Out? ................................................................179

1. The Cause of Our Difficulties ....................................179

2. The Unwanted Solution ..............................................180

Contents — ix

4—T

URRENT

TATUS OF

USINESS

YCLE

ESEARCH

AND

ROSPECTS FOR THE

MMEDIATE

UTURE

(1933) ................................................................................183

I. The Acceptance of the Circulation Credit Theory

of Business Cycles ......................................................................183

II. The Popularity of Low Interest Rates ....................................185

III. The Popularity of Labor Union Policy ..................................187

IV. The Effect of Lower than Unhampered Market

Interest Rates ..............................................................................188

V. The Questionable Fear of Declining Prices ..........................188

5—T

RADE

YCLE AND

REDIT

XPANSION

: T

CONOMIC

ONSEQUENCES OF

HEAP

ONEY

(1946) ....................................191

I. The Unpopularity of Interest ..................................................191

II. The Two Classes of Credit........................................................192

III. The Function of Prices, Wage Rates, and Interest Rates ..195

IV. The Effects of Politically Lowered Interest Rates ................196

V. The Inevitable Ending................................................................201

NDEX

........................................................................................................203

x — The Causes of the Economic Crisis

OREWORD

his collection of articles on the business cycle, money,
and exchange rates by Ludwig von Mises appeared
between 1919 and1946. Here we have the evidence that

the master economist foresaw and warned against the break-
down of the German mark, as well as the market crash of 1929
and the depression that followed. He presents his business cycle
theory in its most elaborate form, applies it to the prevailing con-
ditions, and discusses the policies that governments undertake
that make recessions worse. He recommends a path for monetary
reform that would eliminate business cycles as we have known
them, and provide the basis for a sustainable prosperity.

In foreseeing the interwar economic breakdown, Mises was

nearly alone among his contemporaries—which is particularly
interesting because Mises made no claim to possessing clairvoy-
ant powers. To him, economics is a qualitative discipline. But
among those who say that economics must be quantitative with
the goal of accurate prediction, neither the pre-monetarists of the
Fisher School nor the Keynesians foresaw the economic damage
that would result from central bank policies that manipulate the
supply of money and credit. Why is this? Most economists were
looking at the price level and growth rates as indicators of eco-
nomic health. Mises’s theoretical insights led him to look more
deeply, and to elucidate the impact of credit expansion on the
entire structure of the capitalistic production process.

The essays were well known to contemporary German-speak-

ing audiences. They had not come to the attention of English
audiences until 1978, four years after F.A. Hayek had been
awarded the Nobel Prize for, in particular, “his theory of business

xii — The Causes of the Economic Crisis

cycles and his conception of the effects of monetary and credit
policies.” In tribute to Hayek’s excellent contributions, the
Austrian theory of the business cycle has long been called a
Hayekian theory. But it might be more justly called the Misesian
theory, for it was Mises who first presented it in his 1912 book
and elaborated it so fully in the essays presented herein.

Although the articles address issues that were debated many

years ago, the analysis presented by Mises are as relevant today as
they were in his time. Mises reached his conclusions regarding
events of the day by means of a coherent theory, as applied to
current events, rather than attempting to derive a theory from
data alone, as many of his contemporaries did. This is what gave
his writings their predictive power then, and it is what makes his
writings fresh and relevant today. A proper economic theory
such as Mises presents here applies in all times and places.

As in the past, most economists today believe that sophisti-

cated mathematical and statistical methods can torture the data
enough to reveal some causal link between events and yield a the-
ory of inflation and the business cycle. But this is a senseless
exercise. It is no more fruitful than a purely descriptive account
and it has no more predictive value than a simple data extrapola-
tion.

These essays have been buried in obscurity for far too long.

Reading the writings of this great master economist might con-
vince some economists and policy makers that there is no
substitute for sound thinking. Economics is far too important a
subject to be left in the hands of trend extrapolators, data tortur-
ers, and monetary central planners who rely on them.

RANK

HOSTAK

Chief Economist

MAN Financial Australia

March 2006

NTRODUCTION

Every boom must one day come to an end.

— Ludwig von Mises (1928)

The crisis from which we are now suffering is also the out-
come of a credit expansion.

— Ludwig von Mises (1931)

n the 1912 edition The Theory of Money and Credit, Ludwig
von Mises foresaw the revival of inflation at a time when his
contemporaries believed that no great nation would ever

again resort to irredeemable paper money. This book also pre-
sented his monetary theory of the trade cycle, a fundamental
explanation of economic crises. Mises devoted a great part of his
life to attempts to improve and elaborate on his presentation of
what has since become known as the Austrian trade cycle theory.
This volume includes several of those attempts which have not
previously been available in English.

The first, Stabilization of the Monetary Unit—From the

Viewpoint of Theory, was sent to the printers in January 1923, more
than eight months before the German mark crashed. In this contri-
bution, Mises punctured the then popular fallacy that there is not
enough gold available to serve as a sound medium of exchange.

Adapted from the introduction to Ludwig von Mises, On the Manipulation
of Money and Credit, edited by Percy L. Greaves, translated by Bettina Bien
Greaves (Dobbs Ferry, N.Y.: Free Market Books, 1978).

xiii

xiv — The Causes of the Economic Crisis

The second contribution, Monetary Stabilization and Cyclical

Policy, is probably Mises’s longest and most explicit piece on mis-
guided attempts to stabilize the purchasing power of money and
eliminate the undesired consequences of the “trade cycle.” He
goes into more detail and explains more of the important points
on which the monetary theory of the trade cycle is based than he
does anywhere else. It appeared in 1928 and must have been
completed early that year. Yet, with his usual exceptional fore-
sight, he foresaw the futile policies that the Federal Reserve
System was to follow from the 1928 fall election in the United
States until the stock market crashed the following fall.

Mises pointed out that if it ever became the task of govern-

ments to influence the value of money by manipulating the
quantity of its monetary units, the result would be a continual
struggle of politically powerful groups for favors at the expense of
others. Such struggles can only produce continual disturbances
with results far less “stable” than the rules of the gold standard.

In the first section of this essay, Mises demonstrates the

inevitable failure of all attempts to attain a money with a “stable”
purchasing power by manipulating the quantity. As he expresses
it,

There is no such thing as “stable” purchasing power, and
never can be. The concept of “stable value” is vague and
indistinct. Strictly speaking, only an economy in the
final state of rest—where all prices remain unchanged—
can have a money with fixed purchasing power.

Mises shows conclusively that purchasing power cannot be

measured. Consequently, there is no scientific basis for establish-
ing a starting point for such an unattainable idea. The very
concept of “stable value” denies flexibility to the myriads of mar-
ket prices which actually reflect the ever-changing subjective
values of all participants.

No one knows the future, but so far as market participants can

foresee the future, the anticipated future purchasing power of
any monetary unit will be reflected in the “price premium” factor

Introduction — xv

in market interest rates. If prices are expected to rise continually,
the longer the period of a loan, the higher the interest rate will be.
Before the German mark crashed in 1923, interest rates of 90
percent or more were considered low.

Mises also points out that those who save and lend their sav-

ings to productive efforts play a major role in raising production
and living standards. It would seem that they are entitled to the
free market fruits of their contributions. As just mentioned,
unmanipulated interest rates would reflect market expectations
of changes in the purchasing power of the monetary unit.
However, if the principal of loans could be, and always were,
repaid with sums representing the purchasing power originally
borrowed, the lending savers would be prevented from sharing in
the general progress and resulting lower prices their savings
helped make possible. Then everybody but the lending saver
would benefit from his savings.

This would, of course, reduce the incentive for people to lend

their savings to those who can make a more productive use of
them. With less production, the living standards of all consumers
would fall. So the “stable money” goal, even if it were achievable,
would be a stumbling block to progress. All progress is the result
of free-market incentives which lead enterprisers to attempt to
improve on the “stable” patterns of the past.

Mises also refers to the fact that deflation can never repair the

damage of a priori inflation. In his seminar, he often likened such
a process to an auto driver who had run over a person and then
tried to remedy the situation by backing over the victim in
reverse. Inflation so scrambles the changes in wealth and income
that it becomes impossible to undo the effects. Then too, defla-
tionary manipulations of the quantity of money are just as
destructive of market processes, guided by unhampered market
prices, wage rates and interest rates, as are such inflationary
manipulations of the quantity of money.

The second part of the 1928 piece is a masterpiece in which

Mises shows how the artificial lowering of interest rates intensi-
fies the demand for credit that can only be met by a credit

xvi — The Causes of the Economic Crisis

expansion. This addition to the quantity of money that can be
spent in the market place must lead to a step-by-step redirection
of the economy by raising certain prices and wage rates before
others are affected, as the recipients of this newly created credit
bid for available supplies of what they want but could not buy
without having obtained the newly created credit.

Mises was then writing at a time when such credit expansion

was primarily in the form of discounting short term (not longer
than 90 days) bills of exchange. Consequently, such loans were
always business loans. The first consequence was always a bid-
ding up of the prices of certain raw materials, capital goods, and
wage rates, for which the borrowers spent their newly acquired
credit. This has led some writers on the subject to believe that all
such loans went into the lengthening of the production period.
Some did, of course, but Mises recognized that the lower interest
rates attracted all producers who could use borrowed funds.
Consequently all the resulting malinvestment does not result in
longer processes. The effects depend on just who the borrowers
are and how they spend their new credit in the market.

Since 1928, banks have extended credit expansion not only to

business but also to consumers, and not only for short term loans
but also for long term loans, so that the specific effects of credit
expansion today are somewhat different than they were in the
1920’s. However, the results are still, as Mises pointed out, a step-
by-step misdirection in the use and production of available goods
and services. As Mises wrote in 1928, as well as in Human Action,
the result is not overinvestment, as some have thought, but malin-
vestment. Investment is always limited by what is available.

Although later and better statistics are now available and the

Harvard “barometers” have been superseded by computer mod-
els, what Mises said then about the Harvard “barometers” also
applies to the statistics gathered and rearranged by the more
sophisticated computer techniques of today. Such research mate-
rials may support Mises’s theory, but they provide little help in
furnishing an answer to the problem of finding the cause of
recessions and depressions so that the cause may be eliminated.

Introduction — xvii

The answer, as Mises attests, is a return to free market interest

rates which restrain loans to available savings, i.e., the elimination
of credit expansion, a system whereby banks lend more funds than
they have available for lending by the artificial creation of mone-
tary units in the form of bank accounts subject to withdrawal by
checks. Mises saw the answer in free banking, with banks subject
only to the commercial and bankruptcy laws that apply to all other
forms of business.

In 1928, Mises also foresaw the attempts now being made to

remove the brakes on credit expansion by international agree-
ments. He recognized that if all major governments could ever be
persuaded to expand credit at the same rate, it might then
become more difficult for the residents of individual countries to
detect the expansion or to check the expansion by sending their
funds to countries where there was less credit expansion.

While Mises refined his presentation, particularly his scien-

tific terminology, by the time he wrote Human Action, this 1928
contribution establishes him as the unquestioned originator of
the monetary “Austrian” theory of the trade cycle. Others have
since written on the subject. None has substantially added to, or
subtracted from, his presentation.

This basic explanation is very late in appearing in English. It is

to be hoped that it will correct some of the misunderstandings
resulting from the writings of others that have preceded its
English appearance. This great contribution to human knowl-
edge should be read by all those interested in saving our
capitalistic civilization and capable of spreading a better under-
standing of the inherent dangers to our society in the political
manipulation of money and credit.

The third contribution, The Causes of the Economic Crisis, is a

translation of a speech he gave at the depth of the Great
Depression on February 28, 1931, before a group of German indus-
trialists. After a clear but simple presentation of consumer
sovereignty in an unhampered market society, Mises described
how the lowered interest rates produced the then current crisis. He
goes on to explain the duration of the crisis as the result of other
interventionist hamperings of market processes. He shows that

xviii — The Causes of the Economic Crisis

continued mass unemployment is due to interference with free
market wage rates. He also shows how political interventions
affecting prices, as well as heavy taxes on capital and its yield, had
hindered recovery.

In this speech, five years before the appearance in 1936 of

Keynes’s The General Theory of Employment, Interest and Money,
Mises made a devastating criticism of the basic Keynesian tenet
that has since become so popular. It is the idea that inflation can
bring the higher than free market wage rates extorted by labor
unions into a viable relationship with other costs. Accepting the
idea that it was politically impossible to reduce the higher than
free market union wage rates that had produced mass unemploy-
ment, Keynes proposed to lower the real wages of all workers by
lowering the value of the monetary unit, i.e., inflation.
Unfortunately, England’s inflation only lowered the real wages of
the privileged union members temporarily, while disorganizing
the nation’s whole market economy. This, in turn, created a
clamor for more political interventions that sponsors hoped
would correct the undesired results of the inflation.

Mises correctly foresaw that the politically feared labor unions

would, sooner or later, insist on higher money wages. The even-
tual solution, as Mises has maintained, must be a return to free
market wage rates. He was certainly many years a head of his
time. There is still a popular feeling that inflation is a means of
offsetting unemployment, with little recognition that such infla-
tions must inevitably lead to the undesired recessionary
consequences that every responsible person wants to prevent.

The fourth piece is a translation of a 1933 contribution he

made to Arthur Spiethoff ’s Festschrift devoted to the status and
prospects of business cycle research. Mises used to say that all a
good economist needed was some sound ideas, writing materials,
an armchair, and a waste basket. He, of course, recommended
wide reading but he insisted that it was the ideas that were
important and that without ideas all statistics were meaningless.

In this piece Mises comments on the clamor for cheap credit.

Throughout history there have been governments that have
sponsored high prices and governments that have sponsored low

Introduction — xix

prices, but all governments have been advocates of low interest
rates. Politicians never seem to learn that the best way to attain
low interest rates is to stop inflating the quantity of money and
remove all obstacles to the greater accumulation of capital. Mises
also explodes the naïve inflationist theory that prosperity
requires ever-rising prices.

The final piece is not a translation. It was prepared in early

1946 for an American business association for which Mises served
as a consultant. He discusses his cycle theory in the American
milieu and points out that low interest rates actually hurt the
American masses who, as savings bank depositors, life insurance
policy holders and beneficiaries of pension funds, are the credi-
tors of large corporations and governmental bodies which are
today the major borrowers of savings. He also gives a clear expla-
nation of the important difference between “commodity credit”
and “circulation credit.” It is the latter which is so disastrous in dis-
organizing free market guidelines. Our real problem is not a
shortage of money, but a shortage of the factors of production
needed to produce more of the things that consumers want.

While Mises’s most valuable contributions were not always

easy reading, he did not lapse into abstruse or convoluted esoter-
ics. He wrote what he had to say simply and directly, perhaps on
some occasions too simply and too concisely for many readers to
grasp the full implications which he did not always spell out. He
had a dislike for translations. He maintained that each language
group had some ideas, customs, and traditions which were
impossible to translate accurately into the languages of another
language group with different ideas, customs, and traditions. He
would ask, how could such thoroughly American traditions as
college fraternities and football extravaganzas be translated into
the German language, which had no precise terms for expressing
such alien ideas.

My wife, Bettina Bien Greaves, started these translations a few

years after she became a student of Mises. In the years that have
intervened, she has become one of his most careful students. She
prepared a bibliography of his works, catalogued his library,
attended his seminar for eighteen years, and assisted him in

many ways. In 1971, Mises approved the publication of these
translations when he was assured that they would be edited by
the undersigned, also a long-time and serious student of Mises’s
ideas.

The completion of this project has taken longer than expected.

However, no effort has been spared in the attempt to present
Mises’s ideas in a form we hope he would have approved. We trust
this volume will lead to a better understanding of Mises’s contribu-
tions to man’s knowledge of money, credit, and the trade cycle.

ERCY

L. G

REAVES

, J

DITOR

July 4, 1977

xx — The Causes of the Economic Crisis

ttempts to stabilize the value of the monetary unit
strongly influence the monetary policy of almost every
nation today. They must not be confused with earlier

endeavors to create a monetary unit whose exchange value would
not be affected by changes from the money side.

In those olden,

and happier times, the concern was with how to bring the quan-
tity of money into balance with the demand, without changing
the purchasing power of the monetary unit. Thus, attempts were
made to develop a monetary system under which no changes
would emerge from the side of money to alter the ratios between
the generally used medium of exchange (money) and other eco-
nomic goods. The economic consequences of the widely
deplored changes in the value of money were to be completely
avoided.

Die geldtheoretische Seite des Stabilisierungsproblems (Schriften des Vereins
für Sozialpolitik 164, part 2 [Munich and Leipzig: Duncker and Humblot,
1923]). The original manuscript for this essay was completed and submit-
ted by the author to the printer in January 1923, more than eight months
before the final breakdown of the German mark.

[Following the terminology of Carl Menger, Mises wrote here of changes

in the “internal objective exchange value” of the monetary unit. However,
in this translation, the more familiar English term, later adopted by Mises,
will be used—i.e, changes in the value of the monetary unit arising on the
money side or, simply, “cash-induced changes.” Menger’s term for changes
in the monetary unit’s “external exchange value” will be rendered as
“changes from the goods side” or “goods-induced changes.” See below p. 76,
note 17. Also Mises’s Human Action (1949; 1963 [Chicago: Contemporary
Books, 1966], p. 419; Scholar’s Edition [Auburn, Ala.: Ludwig von Mises
Institute, 1998], p. 416).—Ed.]

TABILIZATION OF THE

ONETARY

NIT

—

ROM THE

IEWPOINT OF

HEORY

(1923)

There is no point nowadays in discussing why this goal could

not then, and in fact cannot, be attained. Today we are motivated
by other concerns. We should be happy just to return again to the
monetary situation we once enjoyed. If only we had the gold stan-
dard back again, its shortcomings would no longer disturb us; we
would just have to make the best of the fact that even the value of
gold undergoes certain fluctuations.

Today’s monetary problem is a very different one. During and

after the war [World War I, 1914–1918], many countries put into
circulation vast quantities of credit money, which were endowed
with legal tender quality. In the course of events described by
Gresham’s Law, gold disappeared from monetary circulation in
these countries. These countries now have paper money, the pur-
chasing power of which is subject to sudden changes. The
monetary economy is so highly developed today that the disadvan-
tages of such a monetary system, with sudden changes brought
about by the creation of vast quantities of credit money, cannot be
tolerated for long. Thus the clamor to eliminate the deficiencies in
the field of money has become universal. People have become con-
vinced that the restoration of domestic peace within nations and
the revival of international economic relations are impossible with-
out a sound monetary system.

UTCOME OF

NFLATION

1. M

ONETARY

EPRECIATION

If the practice persists of covering government deficits with

the issue of notes, then the day will come without fail, sooner or
later, when the monetary systems of those nations pursuing this
course will break down completely. The purchasing power of the

2 — The Causes of the Economic Crisis

[Mises uses the term “inflation” in its historical and scientific sense as an

increase in the quantity of money.—Ed.]

monetary unit will decline more and more, until finally it disap-
pears completely. To be sure, one could conceive of the possibility
that the process of monetary depreciation could go on forever.
The purchasing power of the monetary unit could become
increasingly smaller without ever disappearing entirely. Prices
would then rise more and more. It would still continue to be pos-
sible to exchange notes for commodities. Finally, the situation
would reach such a state that people would be operating with bil-
lions and trillions and then even higher sums for small
transactions. The monetary system would still continue to func-
tion. However, this prospect scarcely resembles reality.

In the long run, trade is not helped by a monetary unit which

continually deteriorates in value. Such a monetary unit cannot be
used as a “standard of deferred payments.”

Another intermediary

must be found for all transactions in which money and goods or
services are not exchanged simultaneously. Nor is a monetary unit
which continually depreciates in value serviceable for cash transac-
tions either. Everyone becomes anxious to keep his cash holding, on
which he continually suffers losses, as low as possible. All incoming
money will be quickly spent. When purchases are made merely to
get rid of money, which is shrinking in value, by exchanging it for
goods of more enduring worth, higher prices will be paid than are
otherwise indicated by other current market relationships.

In recent months, the German Reich has provided a rough

picture of what must happen, once the people come to believe
that the course of monetary depreciation is not going to be
halted. If people are buying unnecessary commodities, or at least
commodities not needed at the moment, because they do not
want to hold on to their paper notes, then the process which
forces the notes out of use as a generally acceptable medium of
exchange has already begun. This is the beginning of the “demon-
etization” of the notes. The panicky quality inherent in the
operation must speed up the process. It may be possible to calm

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 3

[Here in the German text Mises used, without special comment, the

English term “standard of deferred payments.” For his reasons, see below, p.
58, note 3.—Ed.]

4 — The Causes of the Economic Crisis

Bourse (French). A continental European stock exchange, on which

trades are also made in commodities and foreign exchange.

the excited masses once, twice, perhaps even three or four times.
However, matters must finally come to an end. Then there is no
going back. Once the depreciation makes such rapid strides that
sellers are fearful of suffering heavy losses, even if they buy again
with the greatest possible speed, there is no longer any chance of
rescuing the currency.

In every country in which inflation has proceeded at a rapid

pace, it has been discovered that the depreciation of the money
has eventually proceeded faster than the increase in its quantity.
If “m” represents the actual number of monetary units on hand
before the inflation began in a country, “P” represents the value
then of the monetary unit in gold, “M” the actual number of
monetary units which existed at a particular point in time during
the inflation, and “p” the gold value of the monetary unit at that
particular moment, then (as has been borne out many times by
simple statistical studies):

mP > Mp.

On the basis of this formula, some have tried to conclude that

the devaluation had proceeded too rapidly and that the actual
rate of exchange was not justified. From this, others have con-
cluded that the monetary depreciation is not caused by the
increase in the quantity of money, and that obviously the
Quantity Theory could not be correct. Still others, accepting the
primitive version of the Quantity Theory, have argued that a fur-
ther increase in the quantity of money was permissible, even
necessary. The increase in the quantity of money should con-
tinue, they maintain, until the total gold value of the quantity of
money in the country was once more raised to the height at
which it was before the inflation began. Thus:

Mp = mP.

The error in all this is not difficult to recognize. For the

moment, let us disregard the fact—which will be analyzed more
fully below—that at the start of the inflation the rate of exchange
on the Bourse,

as well as the agio [premium] against metals,

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 5

The Treaty of Versailles at the end of World War I (1914–1918) reduced

German controlled territory considerably, restored Alsace-Lorraine to
France, ceded large parts of West Prussia and Posen to Poland, ceded small
areas to Belgium and stripped Germany of her former colonies in Africa
and Asia.

races ahead of the purchasing power of the monetary unit
expressed in commodity prices. Thus, it is not the gold value of
the monetary units, but their temporarily higher purchasing
power vis-à-vis commodities which should be considered. Such a
calculation, with “P” and “p” referring to the monetary unit’s pur-
chasing power in commodities rather than to its value in gold,
would also lead, as a rule, to this result:

mP > Mp.

However, as the monetary depreciation progresses, it is evident

that the demand for money, that is for the monetary units already
in existence, begins to decline. If the loss a person suffers becomes
greater the longer he holds on to money, he will try to keep his
cash holding as low as possible. The desire of every individual for
cash no longer remains as strong as it was before the start of the
inflation, even if his situation may not have otherwise changed. As
a result, the demand for money throughout the entire economy,
which can be nothing more than the sum of the demands for
money on the part of all individuals in the economy, goes down.

To the extent to which trade gradually shifts to using foreign

money and actual gold instead of domestic notes, individuals no
longer invest in domestic notes but begin to put a part of their
reserves in foreign money and gold. In examining the situation in
Germany, it is of particular interest to note that the area in which
Reichsmarks circulate is smaller today than in 1914,

and that now,

because they have become poorer, the Germans have substantially
less use for money. These circumstances, which reduce the demand
for money, would exert much more influence if they were not coun-
teracted by two factors which increase the demand for money:

(1) The demand from abroad for paper marks, which contin-

ues to some extent today, among speculators in foreign
exchange (Valuta); and

6 — The Causes of the Economic Crisis

[The post World War I inflation in Austria is not as well known as the

German inflation of 1923. The Austrian crown depreciated disastrously at
that time, although not to the same extent as the German mark. The leader
of the Christian-Social Party and Chancellor of Austria (1922–1924 and
1926–1929), Dr. Ignaz Seipel (1876–1932), acting on the advice of
Professor Mises and some of his associates, succeeded in stopping the
Austrian inflation in 1922.—Ed.]

(2) The fact that the impairment of [credit] techniques for

making payments, due to the general economic deteriora-
tion, may have increased the demand for money [cash
holdings] above what it would have otherwise been.

2. U

NDESIRED

ONSEQUENCES

If the future prospects for a money are considered poor, its

value in speculations, which anticipate its future purchasing
power, will be lower than the actual demand and supply situation
at the moment would indicate. Prices will be asked and paid
which more nearly correspond to anticipated future conditions
than to the present demand for, and quantity of, money in circu-
lation.

The frenzied purchases of customers who push and shove in the

shops to get something, anything, race on ahead of this develop-
ment; and so does the course of the panic on the Bourse where
stock prices, which do not represent claims in fixed sums of
money, and foreign exchange quotations are forced fitfully upward.
The monetary units available at the moment are not sufficient to
pay the prices which correspond to the anticipated future demand
for, and quantity of, monetary units. So trade suffers from a short-
age of notes. There are not enough monetary units [or notes] on
hand to complete the business transactions agreed upon. The
processes of the market, which bring total demand and supply into
balance by shifting exchange ratios [prices], no longer function so
as to bring about the exchange ratios which actually exist at the
time between the available monetary units and other economic
goods. This phenomenon could be clearly seen in Austria in the
late fall of 1921.

The settling of business transactions suffered seri-

ously from the shortage of notes.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 7

Once conditions reach this stage, there is no possible way to

avoid the undesired consequences. If the issue of notes is further
increased, as many recommend, then things would only be made
still worse. Since the panic would keep on developing, the dispro-
portionality between the depreciation of the monetary unit and
the quantity in circulation would become still more exaggerated.
The shortage of notes for the completion of transactions is a phe-
nomenon of advanced inflation. It is the other side of the frenzied
purchases and prices; it is the other side of the “crack-up boom.”

3. E

FFECT ON

NTEREST

ATES

Obviously, this shortage of monetary units should not be con-

fused with what the businessman usually understands by a
scarcity of money, accompanied by an increase in the interest
rate for short term investments. An inflation, whose end is not in
sight, brings that about also. The old fallacy—long since refuted
by David Hume and Adam Smith—to the effect that a scarcity of
money, as defined in the businessman’s terminology, may be alle-
viated by increasing the quantity of money in circulation, is still
shared by many people. Thus, one continues to hear astonish-
ment expressed at the fact that a scarcity of money prevails in
spite of the uninterrupted increase in the number of notes in cir-
culation. However, the interest rate is then rising, not in spite of,
but precisely on account of, the inflation.

If a halt to the inflation is not anticipated, the money lender

must take into consideration the fact that, when the borrower
ultimately repays the sum of money borrowed, it will then repre-
sent less purchasing power than originally lent out. If the money
lender had not granted credit but instead had used his money
himself to buy commodities, stocks, or foreign exchange, he
would have fared better. In that case, he would have either
avoided loss altogether or suffered a lower loss. If he lends his
money, it is the borrower who comes out well. If the borrower
buys commodities with the borrowed money and sells them later,
he has a surplus after repaying the borrowed sum. The credit
transaction yields him a profit, a real profit, not an illusory, infla-
tionary profit. Thus, it is easy to understand that, as long as the

8 — The Causes of the Economic Crisis

Moneys issued by no longer existing governments. The Romanovs were

thrown out of power in Russia by the Communist Revolution in 1917;
Hungary’s post World War I Communist government lasted only from
March 21, to August 1, 1919.

continuation of monetary depreciation is expected, the money
lender demands, and the borrower is ready to pay, higher interest
rates. Where trade or legal practices are antagonistic to an
increase in the interest rate, the making of credit transactions is
severely hampered. This explains the decline in savings among
those groups of people for whom capital accumulation is possible
only in the form of money deposits at banking institutions or
through the purchase of securities at fixed interest rates.

4. T

UN FROM

ONEY

The divorce of a money, which is proving increasingly useless,

from trade begins when it starts coming out of hoarding. If peo-
ple want marketable goods available to meet unanticipated future
needs, they start to accumulate other moneys—for instance,
metallic (gold and silver) moneys, foreign notes, and occasionally
also domestic notes which are valued more highly because their
quantity cannot be increased by the government, such as the
Romanov ruble of Russia or the “blue” money of Communist
Hungary.

Then too, for the same purpose, people begin to

acquire metal bars, precious stones and pearls, even pictures,
other art objects and postage stamps. An additional step in dis-
placing a no-longer-useful money is the shift to making credit
transactions in foreign currencies or metallic commodity money
which, for all practical purposes, means only gold. Finally, if the
use of domestic money comes to a halt even in commodity trans-
actions, wages too must be paid in some other way than with
pieces of paper with which transactions are no longer being made.

Only the hopelessly confirmed statist can cherish the hope

that a money, continually declining in value, may be maintained
in use as money over the long run. That the German mark is still
used as money today [January 1923] is due simply to the fact that
the belief generally prevails that its progressive depreciation will

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 9

soon stop, or perhaps even that its value per unit will once more
improve. The moment that this opinion is recognized as unten-
able, the process of ousting paper notes from their position as
money will begin. If the process can still be delayed somewhat, it
can only denote another sudden shift of opinion as to the state of
the mark’s future value. The phenomena described as frenzied
purchases have given us some advance warning as to how the
process will begin. It may be that we shall see it run its full course.

Obviously the notes cannot be forced out of their position as

the legal media of exchange, except by an act of law. Even if they
become completely worthless, even if nothing at all could be pur-
chased for a billion marks, obligations payable in marks could
still be legally satisfied by the delivery of mark notes. This means
simply that creditors, to whom marks are owed, are precisely
those who will be hurt most by the collapse of the paper standard.
As a result, it will become impossible to save the purchasing
power of the mark from destruction.

5. E

FFECT OF

PECULATION

Speculators actually provide the strongest support for the

position of the notes as money. Yet, the current statist explana-
tion maintains exactly the opposite. According to this doctrine,
the unfavorable configuration of the quotation for German
money since 1914 is attributed primarily, or at least in large part,
to the destructive effect of speculation in anticipation of its
decline in value. In fact, conditions were such that during the war,
and later, considerable quantities of marks were absorbed abroad
precisely because a future rally of the mark’s exchange rate was
expected. If these sums had not been attracted abroad, they
would necessarily have led to an even steeper rise in prices on the
domestic market. It is apparent everywhere, or at least it was
until recently, that even residents within the country anticipated
a further reduction of prices. One hears again and again, or used
to hear, that everything is so expensive now that all purchases,
except those which cannot possibly be postponed, should be put
off until later. Then again, on the other hand, it is said that the
state of prices at the moment is especially favorable for selling.

However, it cannot be disputed that this point of view is already
on the verge of undergoing an abrupt change.

Placing obstacles in the way of foreign exchange speculation,

and making transactions in foreign exchange futures especially
difficult, was detrimental to the formation of the exchange rate for
notes. Still, not even speculative activity can help at the time when
the opinion becomes general that no hope remains for stopping
the progressive depreciation of the money. Then, even the opti-
mists will retreat from German marks and Austrian crowns, part
company with those who anticipate a rise and join with those who
expect a decline. Once only one view prevails on the market, there
can be no more exchanges based on differences of opinion.

6. F

INAL

HASES

The process of driving notes out of service as money can take

place either relatively slowly or abruptly in a panic, perhaps in
days or even hours. If the change takes place slowly that means
trade is shifting, step-by-step, to the general use of another
medium of exchange in place of the notes. This practice of mak-
ing and settling domestic transactions in foreign money or in gold,
which has already reached substantial proportions in many
branches of business, is being increasingly adopted. As a result, to
the extent that individuals shift more and more of their cash hold-
ings from German marks to foreign money, still more foreign
exchange enters the country. As a result of the growing demand
for foreign money, various kinds of foreign exchange, equivalent
to a part of the value of the goods shipped abroad, are imported
instead of commodities. Gradually, there is accumulated within
the country a supply of foreign moneys. This substantially softens
the effects of the final breakdown of the domestic paper standard.
Then, if foreign exchange is demanded even in small transactions,
if, as a result, even wages must be paid in foreign exchange, at first
in part and then in full, if finally even the government recognizes
that it must do the same when levying taxes and paying its offi-
cials, then the sums of foreign money needed for these purposes
are, for the most part, already available within the country. The

10 — The Causes of the Economic Crisis

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 11

Horace White, Money and Banking: Illustrated by American History

(Boston, 1895), p. 142. [NOTE: We could not locate a copy of the 1895 edi-
tion to verify this quotation. However, it appears, without the last sentence,
in the 5th (1911) edition, p. 99.—Ed.]

situation, which emerges then from the collapse of the govern-
ment’s currency, does not necessitate barter, the cumbersome
direct exchange of commodities against commodities. Foreign
money from various sources then performs the service of money,
even if somewhat unsatisfactorily.

Not only do incontrovertible theoretical considerations lead

to this hypothesis. So does the experience of history with cur-
rency breakdowns. With reference to the collapse of the
“Continental Currency” in the rebellious American colonies
(1781), Horace White says: “As soon as paper was dead, hard
money sprang to life, and was abundant for all purposes. Much
had been hoarded and much more had been brought in by the
French and English armies and navies. It was so plentiful that for-
eign exchange fell to a discount.”

In 1796, the value of French territorial mandats fell to zero.

Louis Adolphe Thiers commented on the situation as follows:

Nobody traded except for metallic money. The specie, which
people had believed hoarded or exported abroad, found its
way back into circulation. That which had been hidden
appeared. That which had left France returned. The southern
provinces were full of piasters, which came from Spain, drawn
across the border by the need for them. Gold and silver, like
all commodities, go wherever demand calls them. An
increased demand raises what is offered for them to the point
that attracts a sufficient quantity to satisfy the need. People
were still being swindled by being paid in mandats, because
the laws, giving legal tender value to paper money, permitted
people to use it for the satisfaction of written obligations. But
few dared to do this and all new agreements were made in
metallic money. In all markets, one saw only gold or silver.
The workers were also paid in this manner. One would have
said there was no longer any paper in France. The mandats
were then found only in the hands of speculators, who

12 — The Causes of the Economic Crisis

Louis Adolphe Thiers, Histoire de la Revolution Française, 7th ed., vol.

V (Brussels, 1838), p. 171. The interpretation placed on these events by the
“School” of G.F. Knapp is especially fantastic. See H. Illig’s Das Geldwesen
Frankreichs zur Zeit der ersten Revolution bis zum Ende der
Papiergeldwährung [The French monetary system at the time of the first
revolution to the end of the paper currency] (Strassburg, 1914), p. 56. After
mentioning attempts by the state to “manipulate the exchange rate of sil-
ver,” he points out: “Attempts to reintroduce the desired cash situation
began to succeed in 1796.” Thus, even the collapse of the paper money
standard was a “success” for the State Theory of Money. [NOTE: The “State
Theory of Money” has been the basis of the monetary policies of most gov-
ernments in this century. Mises frequently credited the book of Georg
Friedrich Knapp (3rd German edition, 1921; English translation by H.M.
Lucas and J. Bonar, State Theory of Money, London, 1924) for having pop-
ularized it among German-speaking peoples. Knapp held that money was
whatever the government decreed to be money—individuals acting and
trading on the market had nothing to do with it. See Mises’s The Theory of
Money and Credit (New Haven, Conn.: Yale University Press, 1953), pp.
463–69; and (Indianapolis, Ind.: LibertyClassics, 1980), pp. 506–12.—Ed.]

received them from the government and resold them to the
buyers of national lands. In this way, the financial crisis,
although still existing for the state, had almost ended for pri-
vate persons.

7. G

REATER

MPORTANCE OF

ONEY

TO A

ODERN

CONOMY

Of course, one must be careful not to draw a parallel between

the effects of the catastrophe, toward which our money is racing
headlong on a collision course, with the consequences of the two
events described above. In 1781, the United States was a predom-
inantly agricultural country. In 1796, France was also at a much
lower stage in the economic development of the division of labor
and use of money and, thus, in cash and credit transactions. In an
industrial country, such as Germany, the consequences of a mon-
etary collapse must be entirely different from those in lands
where a large part of the population remains submerged in prim-
itive economic conditions.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 13

Things will necessarily be much worse if the breakdown of the

paper money does not take place step-by-step, but comes, as now
seems likely, all of a sudden in panic. The supplies within the
country of gold and silver money and of foreign notes are
insignificant. The practice, pursued so eagerly during the war, of
concentrating domestic stocks of gold in the central banks and
the restrictions, for many years placed on trade in foreign mon-
eys, have operated so that the total supplies of hoarded good
money have long been insufficient to permit a smooth develop-
ment of monetary circulation during the early days and weeks
after the collapse of the paper note standard. Some time must
elapse before the amount of foreign money needed in domestic
trade is obtained by the sale of stocks and commodities, by rais-
ing credit, and by withdrawing balances from abroad. In the
meantime, people will have to make out with various kinds of
emergency money tokens.

Precisely at the moment when all savers and pensioners are

most severely affected by the complete depreciation of the notes,
and when the government’s entire financial and economic policy
must undergo a radical transformation, as a result of being denied
access to the printing press, technical difficulties will emerge in
conducting trade and making payments. It will become immedi-
ately obvious that these difficulties must seriously aggravate the
unrest of the people. Still, there is no point in describing the spe-
cific details of such a catastrophe. They should only be referred to
in order to show that inflation is not a policy that can be carried on
forever. The printing presses must be shut down in time, because
a dreadful catastrophe awaits if their operations go on to the end.
No one can say how far we still are from such a finish.

It is immaterial whether the continuation of inflation is con-

sidered desirable or merely not harmful. It is immaterial whether
inflation is looked on as an evil, although perhaps a lesser evil in
view of other possibilities. Inflation can be pursued only so long
as the public still does not believe it will continue. Once the peo-
ple generally realize that the inflation will be continued on and on
and that the value of the monetary unit will decline more and

14 — The Causes of the Economic Crisis

Foreign currencies and similar legal claims could possibly be classed as

foreign money. However, foreign money here obviously means only the
money of countries with at least fairly sound monetary conditions.

more, then the fate of the money is sealed. Only the belief, that
the inflation will come to a stop, maintains the value of the notes.

II.

MANCIPATION OF

ONETARY

ALUE

ROM THE

NFLUENCE OF

OVERNMENT

1. S

TOP

RESSES AND

REDIT

XPANSION

The first condition of any monetary reform is to halt the print-

ing presses. Germany must refrain from financing government
deficits by issuing notes, directly or indirectly. The Reichsbank
[Germany’s central bank from 1875 until shortly after World War
II] must not further expand its notes in circulation. Reichsbank
deposits should be opened and increased, only upon the transfer
of already existing Reichsbank accounts, or in exchange for pay-
ment in notes, or other domestic or foreign money. The
Reichsbank should grant credits only to the extent that funds are
available—from its own reserves and from other resources put at
its disposal by creditors. It should not create credit to increase
the amount of its notes, not covered by gold or foreign money, or
to raise the sum of its outstanding liabilities. Should it release any
gold or foreign money from its reserves, then it must reduce to
that same extent the circulation of its notes or the use of its obli-
gations in transfers.

Absolutely no evasions of these conditions should be

tolerated. However, it might be possible to permit a limited increase
—for two or three weeks at a time—only to facilitate clearings at the

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 15

[Mises later developed his position on these matters more fully. He

withdrew his endorsement of even such a carefully prescribed legal exemp-
tion as this to his general thesis that money and banking should be free of
legislative interference. Even clearing arrangements among the banks
should be left to the vicissitudes of the market. See his plea for free bank-
ing in Monetary Stabilization and Cyclical Policy (1928) in this volume
especially pp. 124–25 below. Also in Human Action, chapter XVII, section
12 on “Indirect Exchange” and the essay on “Monetary Reconstruction”
written for publication as the Epilogue to the 1953 (and later) editions of
The Theory of Money and Credit.—Ed.]

end of quarters, especially at the close of September and December.
This additional circulation credit introduced into the economy,
above the otherwise strictly-adhered to limits, should be statisti-
cally moderate and generally precisely prescribed by law.

There can be no doubt but what this would bring the contin-

uing depreciation of the monetary unit to an immediate and
effective halt. An increase in the purchasing power of the
German monetary unit would even appear then—to the extent
that the previous purchasing power of the German monetary
unit, relative to that of commodities and foreign exchange,
already reflected the view that the inflation would continue. This
increase in purchasing power would rise to the point which cor-
responded to the actual situation.

2. R

ELATIONSHIP OF

ONETARY

NIT TO

ORLD

ONEY

—G

OLD

However, stopping the inflation by no means signifies stabi-

lization of the value of the German monetary unit in terms of
foreign money. Once strict limits are placed on any further infla-
tion, the quantity of German money will no longer be changing.
Still, with changes in the demand for money, changes will also be
taking place in the exchange ratios between German and foreign
moneys. The German economy will no longer have to endure the
disadvantages that come from inflation and continual monetary
depreciation; but it will still have to face the consequences of the
fact that foreign exchange rates remain subject to continual, even
if not severe, fluctuations.

16 — The Causes of the Economic Crisis

If, with the suspension of printing press operations, the mone-

tary policy reforms are declared at an end, then obviously the
value of the German monetary unit in relation to the world
money, gold, would rise, slowly but steadily. For the supply of gold,
used as money, grows steadily due to the output of mines while
the quantity of the German money [not backed by gold or foreign
money] would be limited once and for all. Thus, it should be con-
sidered quite likely that the repercussions of changes in the
relationship between the quantity of, and demand for, money in
Germany and in gold standard countries would cause the German
monetary unit to rise on the foreign exchange market. An illustra-
tion of this is furnished by the developments of the Austrian
money on the foreign exchange market in the years 1888–1891.

To stabilize the relative value of the monetary unit beyond a

nation’s borders, it is not enough simply to free the formation of
monetary value from the influence of government. An effort
should also be made to establish a connection between the world
money and the German monetary unit, firmly binding the value
of the Reichsmark to the value of gold.

It should be emphasized again and again that stabilization of

the gold value of a monetary unit can only be attained if the print-
ing presses are silenced. Every attempt to accomplish this by other
means is futile. It is useless to interfere on the foreign exchange
market. If the German government acquires dollars, perhaps
through a loan, and sells the loan for paper marks, it is exerting
pressure, in the process, on the dollar exchange rate. However, if
the printing presses continue to run, the monetary depreciation
will only be slowed down, not brought to a standstill as a result.
Once the impetus of the intervention is exhausted, then the
depreciation resumes again, even more rapidly. However, if the
increase in notes has actually stopped, no intervention is needed
to stabilize the mark in terms of gold.

3. T

REND OF

EPRECIATION

In this connection, it is pointed out that the increase in notes

and the depreciation of the monetary unit do not exactly coincide
chronologically. The value of the monetary unit often remains

In power from March 21, to August 1, 1919, only.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 17

almost stable for weeks and even months, while the supply of
notes increases continually. Then again, commodity prices and
foreign exchange quotations climb sharply upward, in spite of the
fact that the current increase in notes is not proceeding any faster
or may even be slowing down. The explanation for this lies in the
processes of market operations. The tendency to exaggerate
every change is inherent in speculation. Should the conduct inau-
gurated by the few, who rely on their own independent judgment,
be exaggerated and carried too far by those who follow their lead,
then a reaction, or at least a standstill, must take place. So igno-
rance of the principles underlying the formation of monetary
value leads to a reaction on the market.

In the course of speculation in stocks and securities, the spec-

ulator has developed the procedure which is his tool in trade.
What he learned there he now tries to apply in the field of foreign
exchange speculations. His experience has been that stocks
which have dropped sharply on the market usually offer favorable
investment opportunities and so he believes the situation to be
similar with respect to the monetary unit. He looks on the mon-
etary unit as if it were a share of stock in the government. When
the German mark was quoted in Zurich at 10 francs, one banker
said: “Now is the time to buy marks. The German economy is
surely poorer today than before the war so that a lower evaluation
for the mark is justified. Yet the wealth of the German people has
certainly not fallen to a twelfth of their prewar assets. Thus, the
mark must rise in value.” And when the Polish mark had fallen to
5 francs in Zurich, another banker said: “To me this low price is
incomprehensible! Poland is a rich country. It has a profitable
agricultural economy, forests, coal, petroleum. So the rate of
exchange should be considerably higher.”

Similarly, in the spring of 1919, a leading official of the

Hungarian Soviet Republic

told me: “Actually, the paper money

issued by the Hungarian Soviet Republic should have the highest
rate of exchange, except for that of Russia. Next to the Russian
government, the Hungarian government, by socializing private

18 — The Causes of the Economic Crisis

property throughout Hungary, has become the richest and thus
the most credit-worthy in the world.”

These observers do not understand that the valuation of a

monetary unit depends not on the wealth of a country, but rather
on the relationship between the quantity of, and demand for,
money. Thus, even the richest country can have a bad currency
and the poorest country a good one. Nevertheless, even though
the theory of these bankers is false, and must eventually lead to
losses for all who use it as a guide for action, it can temporarily
slow down and even put a stop to the decline in the foreign
exchange value of the monetary unit.

III.

ETURN TO

OLD

1. E

MINENCE OF

OLD

In the years preceding and during the war, the authors who

prepared the way for the present monetary chaos were eager to
sever the connection between the monetary standard and gold.
So, in place of a standard based directly on gold, it was proposed
to develop a standard which would promise no more than a con-
stant exchange ratio in foreign money. These proposals, insofar
as they aimed at transferring control over the formulation of
monetary value to government, need not be discussed any fur-
ther. The reason for using a commodity money is precisely to
prevent political influence from affecting directly the value of the
monetary unit. Gold is not the standard money solely on account
of its brilliance or its physical and chemical characteristics. Gold
is the standard money primarily because an increase or decrease
in the available quantity is independent of the orders issued by
political authorities. The distinctive feature of the gold standard
is that it makes changes in the quantity of money dependent on
the profitability of gold production.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 19

Carl A. Schaefer, Klassische Valutastabilisierungen (Hamburg, 1922),

p. 65.

Instead of the gold standard, a monetary standard based on a

foreign currency could be introduced. The value of the mark
would then be related, not to gold, but to the value of a specific
foreign money, at a definite exchange ratio. The Reichsbank
would be ready at all times to buy or sell marks, in unlimited
quantities at a fixed exchange rate, against the specified foreign
money. If the monetary unit chosen as the basis for such a system
is not on a sound gold standard, the conditions created would be
absolutely untenable. The purchasing power of the German
money would then hinge on fluctuations in the purchasing power
of that foreign money. German policy would have renounced its
influence on the creation of monetary value for the benefit of the
policy of a foreign government. Then too, even if the foreign
money, chosen as the basis for the German monetary unit, were
on an absolutely sound gold standard at the moment, the possi-
bility would remain that its tie to gold might be cut at some later
time. So there is no basis for choosing this roundabout route in
order to attain a sound monetary system. It is not true that adopt-
ing the gold standard leads to economic dependence on England,
gold producers, or some other power. Quite the contrary! As a
matter of fact, it is the monetary standard which relies on the
money of a foreign government that deserves the name of a “sub-
sidiary [dependent] or vassal standard.”

2. S

UFFICIENCY OF

VAILABLE

OLD

There are no grounds for saying that there is not enough gold

available to enable all the countries in the world to have the gold
standard. There can never be too much, nor too little, gold to
serve the purpose of money. Supply and demand are brought into
balance by the formation of prices. Nor is there reason to fear
that prices generally would be depressed too severely by a return
to the gold standard on the part of countries with depreciated
currencies. The world’s gold supplies have not decreased since
1914. They have increased. In view of the decline in trade and the

20 — The Causes of the Economic Crisis

[By 1928, when Mises wrote “Monetary Stabilization and Cyclical

Policy,” the second essay in this volume, he had rejected the flexible (gold
exchange) standard (see below, pp. 60ff.) pointing out that the only hope of
curbing the powerful political incentives to inflate lay in having a “pure”
gold coin standard. He “confessed” this shift in views in Human Action (1st
ed., 1949, p. 780; 2nd and 3rd eds., 1963 and 1966, p. 786; Scholar’s Edition
1998, p. 780).—Ed.]

Chartism, an English working class movement, arose as a revolt against

the Poor Law of 1835 which forced those able to work to enter workhouses
before receiving public support. The movement was endorsed by both
Marx and Engels and accepted the labor theory of value. Its members
included those seeking inconvertible paper money and all sorts of political
interventions and welfare measures. The advocates of various schemes
were unified only in the advocacy of a charter providing for universal adult
male suffrage, which each faction thought would lead to the adoption of its
particular nostrums. Chartists’s attempts to obtain popular support failed
conspicuously and after 1848 the movement faded away.

increase in poverty, the demand for gold should be lower than it
was before 1914, even after a complete return to the gold stan-
dard. After all, a return to the gold standard would not mean a
return to the actual use of gold money within the country to pay
for small- and medium-sized transactions. For even the gold
exchange standard [Goldkernwährung] developed by Ricardo in
his work, Proposals for an Economical and Secure Currency
(1816), is a legitimate and adequate gold standard,

as the his-

tory of money in recent decades clearly shows.

Basing the German monetary system on some foreign money

instead of the metal gold would have only one significance: By
obscuring the true nature of reform, it would make a reversal eas-
ier for inflationist writers and politicians. The first condition of
any real monetary reform is still to rout completely all populist
doctrines advocating Chartism,

the creation of money, the

dethronement of gold and free money. Any imperfection and lack
of clarity here is prejudicial. Inflationists of every variety must be
completely demolished. We should not be satisfied to settle for
compromises with them. The slogan, “Down with gold,” must be
ousted. The solution rests on substituting in its place: “No gov-
ernmental interference with the value of the monetary unit!”

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 21

IV.

ONEY

ELATION

1. V

ICTORY AND

NFLATION

No one can any longer maintain seriously that the rate of

exchange for the German paper mark could be reestablished [in
1923] at its old gold value—as specified by the legislation of
December 4, 1871, and by the coinage law of July 9, 1873. Yet
many still resist the proposal to stabilize the gold value of the
mark at the currently low rate. Rather vague considerations of
national pride are often marshaled against it. Deluded by false
ideas as to the causes of monetary depreciation, people have been
in the habit of looking on a country’s currency as if it were the
capital stock of the fatherland and of the government. People
believe that a low exchange rate for the mark is a reflection of an
unfavorable judgment as to the political and economic situation
in Germany. They do not understand that monetary value is
affected only by changes in the relation between the demand for,
and quantity of, money and the prevailing opinion with respect
to expected changes in that relationship, including those pro-
duced by governmental monetary policies.

During the course of the war, it was said that “the currency of

the victor” would turn out to be the best. But war and defeat on
the field of battle can only influence the formation of monetary
value indirectly. It is generally expected that a victorious govern-
ment will be able to stop the use of the printing press sooner. The
victorious government will find it easier both to restrict its
expenditures and to obtain credit. This same interpretation
would also argue that the rate of exchange of the defeated coun-
try would become more favorable as the prospects for peace
improved. The values of both the German mark and the Austrian
crown rose in October 1918. It was thought that a halt to the
inflation could be expected even in Germany and Austria, but
obviously this expectation was not fulfilled.

22 — The Causes of the Economic Crisis

History shows that the foreign exchange value of the “victor’s

money” may also be very low. Seldom has there been a more bril-
liant victory than that finally won by the American rebels under
Washington’s leadership over the British forces. Yet the
American money did not benefit as a result. The more proudly
the Star Spangled Banner was raised, the lower the exchange rate
fell for the “Continentals,” as the paper notes issued by the rebel-
lious states were called. Then, just as the rebels’ victory was
finally won, these “Continentals” became completely worthless.
A short time later, a similar situation arose in France. In spite of
the victory achieved by the Revolutionists, the agio [premium]
for the metal rose higher and higher until finally, in 1796, the
value of the paper monetary unit went to zero. In each case, the
victorious government pursued inflation to the end.

2. E

STABLISHING

OLD

“R

ATIO

”

It is completely wrong to look on “devaluation” as governmen-

tal bankruptcy. Stabilization of the present depressed monetary
value, even if considered only with respect to its effect on the
existing debts, is something very different from governmental
bankruptcy. It is both more and, at the same time, less than gov-
ernmental bankruptcy. It is more than governmental bankruptcy
to the extent that it affects not only public debts, but also all pri-
vate debts. It is less than governmental bankruptcy to the extent
that it affects only the government’s outstanding debts payable in
paper money, while leaving undisturbed its obligations payable in
hard money or foreign currency. Then too, monetary stabiliza-
tion brings with it no change in the relationships among
contracting parties, with respect to paper money debts already
contracted without any assurance of an increase in the value of
the money.

To compensate the owners of claims to marks for the losses

suffered, between 1914 and 1923, calls for something other than
raising the mark’s exchange rate. Debts originating during this
period would have to be converted by law into obligations
payable in old gold marks according to the mark’s value at the
time each obligation was contracted. It is extremely doubtful if

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 23

the desired goal could be attained even by this means. The pres-
ent title-holders to claims are not always the same ones who have
borne the loss. The bulk of claims outstanding are represented by
securities payable to the bearer and a considerable portion of all
other claims have changed hands in the course of the years.
When it comes to determining the currency profits and losses
over the years, accounting methods are presented with tremen-
dous obstacles by the technology of trade and the legal structure
of business.

The effects of changes in general economic conditions on

commerce, especially those of every cash-induced change in
monetary value, and every increase in its purchasing power, mil-
itate against trying to raise the value of the monetary unit before
[redefining and] stabilizing it in terms of gold. The value of the
monetary unit should be [legally defined and] stabilized in terms
of gold at the rate (ratio) which prevails at the moment.

As long as monetary depreciation is still going on, it is obvi-

ously impossible to speak of a specific “rate” for the value of
money. For changes in the value of the monetary unit do not
affect all goods and services throughout the whole economy at
the same time and to the same extent. These changes in mone-
tary value necessarily work themselves out irregularly and
step-by-step. It is generally recognized that in the short, or even
the longer run, a discrepancy may exist between the value of the
monetary unit, as expressed in the quotation for various foreign
currencies, and its purchasing power in goods and services on
the domestic market.

The quotations on the Bourse for foreign exchange always

reflect speculative rates in the light of the currently evolving, but
not yet consummated, change in the purchasing power of the
monetary unit. However, the monetary depreciation, at an early
stage of its gradual evolution, has already had its full impact on for-
eign exchange rates before it is fully expressed in the prices of all
domestic goods and services. This lag in commodity prices, behind
the rise of the foreign exchange rates, is of limited duration. In the
last analysis, the foreign exchange rates are determined by nothing
more than the anticipated future purchasing power attributed to a

24 — The Causes of the Economic Crisis

[Mises later came to prefer the term “final rate” or the rate that would

prevail if a “final state of rest,” reflecting the final effects of all changes
already initiated, were actually reached. See Human Action, chapter XIV,
section 5.—Ed.]

[For a later elaboration of this position, see Mises’s “Monetary

Reconstruction,” epilogue to the 1953 (and later) editions of The Theory of
Money and Credit.—Ed.]

unit of each currency. The foreign exchange rates must be estab-
lished at such heights that the purchasing power of the monetary
unit remains the same, whether it is used to buy commodities
directly, or whether it is first used to acquire another currency with
which to buy the commodities. In the long run the rate cannot
deviate from the ratio determined by its purchasing power. This
ratio is known as the “natural” or “static” rate.

In order to stabilize the value of a monetary unit at its present

value, the decline in monetary value must first be brought to a
stop. The value of the monetary unit in terms of gold must first
attain some stability. Only then can the relationship of the mone-
tary unit to gold be given any lasting status. First of all, as pointed
out above, the progress of inflation must be blocked by halting any
further increase in the issue of notes. Then one must wait a while
until after foreign exchange quotations and commodity prices,
which will fluctuate for a time, have become adjusted. As has
already been explained, this adjustment would come about not
only through an increase in commodity prices but also, to some
extent, with a drop in the foreign exchange rate.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 25

OMMENTS ON THE

“B

ALANCE

AYMENTS

” D

OCTRINE

1. R

EFINED

UANTITY

HEORY OF

ONEY

The generally accepted doctrine maintains that the establish-

ment of sound relationships among currencies is possible only
with a “favorable balance of payments.” According to this view, a
country with an “unfavorable balance of payments” cannot main-
tain the stability of its monetary value. In this case, the
deterioration in the rate of exchange is considered structural and
it is thought it may be effectively counteracted only by eliminat-
ing the structural defects.

The answer to this and to similar arguments is inherent in the

Quantity Theory and in Gresham’s Law.

The Quantity Theory demonstrated that in a country which

uses only commodity money, the “purely metallic currency” stan-
dard of the Currency Theory, money can never flow abroad
continuously for any length of time. The outflow of a part of the
gold supply brings about a contraction in the quantity of money
available in the domestic market. This reduces commodity
prices, promotes exports and restricts imports, until the quantity
of money in the domestic economy is replenished from abroad.
The precious metals being used as money are dispersed among
the various individual enterprises and thus among the several
national economies, according to the extent and intensity of their
respective demands for money. Governmental interventions,
which seek to regulate international monetary movements in
order to assure the economy a “needed” quantity of money, are
superfluous.

The undesirable outflow of money must always be simply the

result of a governmental intervention which has endowed differ-
ently valued moneys with the same legal purchasing power. All

26 — The Causes of the Economic Crisis

that the government need do to avoid disrupting the monetary
situation, and all it can do, is to abandon such interventions. That
is the essence of the monetary theory of Classical economics and
of those who follow in its footsteps, the theoreticians of the
Currency School.

With the help of modern subjective theory, this theory can be

more thoroughly developed and refined. Still it cannot be demol-
ished. And no other theory can be put in its place. Those who can
ignore this theory only demonstrate that they are not econo-
mists.

2. P

URCHASING

OWER

ARITY

One frequently hears, when commodity money is being

replaced in one country by credit or token money—because the
legally-decreed equality between the over-issued paper and the
metallic money has prompted the sequence of events described
by Gresham’s Law—that it is the balance of payments that deter-
mines the rates of foreign exchange. That is completely wrong.
Exchange rates are determined by the relative purchasing power
per unit of each kind of money. As pointed out above, exchange
rates must eventually be established at a height at which it makes
no difference whether one uses a piece of money directly to buy
a commodity, or whether one first exchanges this money for units
of a foreign currency and then spends that foreign currency for
the desired commodity. Should the rate deviate from that deter-
mined by the purchasing power parity, which is known as the
“natural” or “static” rate, an opportunity would emerge for under-
taking profit-making ventures.

It would then be profitable to buy commodities with the

money which is legally undervalued on the exchange, as com-
pared with its purchasing power parity, and to sell those
commodities for that money which is legally overvalued on the
exchange, as compared with its actual purchasing power.
Whenever such opportunities for profit exist, buyers would

[See Mises’s The Theory of Money and Credit, pp. 180–86; 1980, pp.

207–13.—Ed.]

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 27

See my paper “Zahlungsbilanz und Valutenkurse,” Mitteilungen des

Verbandes österreichischer Banken und Bankiers II (1919): 39ff. [NOTE:
Pertinent excerpts from this explanation of the “balance of payments” fal-
lacy have been translated and appear here in the Appendix, pp. 44–51. See
also Human Action, 1966, pp. 450–58; 1998, pp. 447–55.—Ed.]

appear on the foreign exchange market with a demand for the
undervalued money. This demand drives the exchange up until it
reaches its “final rate.”

Foreign exchange rates rise because the

quantity of the [domestic] money has increased and commodity
prices have risen. As has already been explained, it is only
because of market technicalities that this cause and effect rela-
tionship is not revealed in the early course of events as well.
Under the influence of speculation, the configuration of foreign
exchange rates on the Bourse forecasts anticipated future
changes in commodity prices.

The balance of payments doctrine overlooks the fact that the

extent of foreign trade depends entirely on prices. It disregards
the fact that nothing can be imported or exported if price differ-
ences, which make the trade profitable, do not exist. The balance
of payments doctrine derives from superficialities. Anyone who
simply looks at what is taking place on the Bourse every day and
every hour sees, to be sure, only that the momentary state of the
balance of payments is decisive for supply and demand on the
foreign exchange market. Yet this diagnosis is merely the start of
the inquiry into the factors determining foreign exchange rates.
The next question is: What determines the momentary state of
the balance of payments? This must lead only to the conclusion
that the balance of payments is determined by the structure of
prices and by the sales and purchases inspired by differences in
prices.

3. F

OREIGN

XCHANGE

ATES

With rising foreign exchange quotations, foreign commodities

can be imported only if they find buyers at their higher prices.
One version of the balance of payments doctrine seeks to distin-
guish between the importation of necessities of life and articles

28 — The Causes of the Economic Crisis

From the tremendous literature on the subject, I will mention here only

T.E. Gregory’s Foreign Exchange Before, During and After the War (London,
1921).

which are considered less vital or necessary. It is thought that the
necessities of life must be obtained at any price, because it is
absolutely impossible to get along without them. As a result, it is
held that a country’s foreign exchange must deteriorate continu-
ously if it must import vitally-needed commodities while it can
export only less-necessary items. This reasoning ignores the fact
that the greater or lesser need for certain goods, the size and
intensity of the demand for them, or the ability to get along with-
out them, is already fully expressed by the relative height of the
prices assigned to the various goods on the market.

No matter how strong a desire the Austrians may have for for-

eign bread, meat, coal or sugar, they can satisfy this desire only if
they can pay for them. If they want to import more, they must
export more. If they cannot export more manufactured, or semi-
manufactured, goods, they must export shares of stock, bonds,
and titles to property of various kinds.

If the quantity of notes were not increased, then the prices of

the items for sale would be lower. If they then demand more
imported goods, the prices of these imported items must rise. Or
else the rise in the prices of vital necessities must be offset by a
decline in the prices of less vital articles, the purchase of which is
restricted to permit the purchase of more necessities. Thus a
general rise in prices is out of the question [without an increase
in the quantity of notes]. The international payments would
come into balance either with an increase in the export of dispen-
sable goods or with the export of securities and similar items. It
is only because the quantity of notes has been increased that they
can maintain their imports at the higher exchange rates without
increasing their exports. This is the only reason that the increase
in the rate of exchange does not completely choke off imports
and encourage exports until the “balance of payments” is once
again “favorable.”

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 29

Certainly no proof is needed to demonstrate that speculation

is not responsible for the deterioration of the foreign exchange
situation. The foreign exchange speculator tries to anticipate
prospective fluctuations in rates. He may perhaps blunder. In that
case he must pay for his mistakes. However, speculators can
never maintain for any length of time a quotation which is not in
accord with market ratios. Governments and politicians, who
blame the deterioration of the currency on speculation, know
this very well. If they thought differently with respect to future
foreign exchange rates, they could speculate for the government’s
account, against a rise and in anticipation of a decline. By this sin-
gle act they could not only improve the foreign exchange rate, but
also reap a handsome profit for the Treasury.

4. F

OREIGN

XCHANGE

EGULATIONS

The ancient Mercantilist fallacies paint a specter which we

have no cause to fear. No people, not even the poorest, need
abandon sound monetary policy. It is neither the poverty of the
individual nor of the group, it is neither foreign indebtedness nor
unfavorable conditions of production, that drives foreign
exchange rates way up. Only inflation does this.

Consequently, every other means employed in the struggle

against the rise in foreign exchange rates is useless. If the infla-
tion continues, they will be ineffective. If there is no inflation,
they are superfluous. The most significant of these other means
is the prohibition or, at least, the restriction of the importation
of certain goods which are considered dispensable, or at least
not vitally necessary. The sums of money within the country
which would have been spent for the purchase of these goods are
now used for other purchases. Obviously, the only goods
involved are those which would otherwise have been sold
abroad. These goods are now bought by residents within the
country at prices higher than those bid for them by foreigners.
As a result, on the one side there is a decline in imports and thus
in the demand for foreign exchange, while on the other side
there is an equally large reduction in exports and thus also a
decline in the supply of foreign exchange. Imports are paid for

30 — The Causes of the Economic Crisis

by exports, not with money as the superficial Neo-mercantilist
doctrine still maintains.

If one really wants to check the demand for foreign exchange,

then, to the extent that one wants to reduce imports, money
must actually be taken away from the people—perhaps through
taxes. This sum should be completely withdrawn from circula-
tion, not even given out for government purposes, but rather
destroyed. This means adopting a policy of deflation. Instead of
restricting the importation of chocolate, wine and cigarettes, the
sums people would have spent for these commodities must be
taken away from them. The people would then either have to
reduce their consumption of these or of some other commodi-
ties. In the former case [i.e., if the consumption of imported
goods is reduced] less foreign exchange is sought. In the latter
case [i.e., if the consumption of domestic articles declines] more
goods are exported and thus more foreign exchange becomes
available.

It is equally impossible to influence the foreign exchange mar-

ket by prohibiting the hoarding of foreign moneys. If the people
mistrust the reliability of the value of the notes, they will seek to
invest a portion of their cash holdings in foreign money. If this is
made impossible, then the people will either sell fewer commodi-
ties and stocks or they will buy more commodities, stocks, and
the like. However, they will certainly not hold more domestic
currency in place of foreign exchange. In any case, this behavior
reduces total exports. The demand for foreign exchange for
hoarding disappears and, at the same time, the supply of foreign
exchange coming into the country in payment of exports
declines. Incidentally, it may be mentioned that making it more
difficult to amass foreign exchange hampers the accumulation of
a reserve fund that could help the economy weather the critical
time which immediately follows the collapse of a paper monetary
standard. As a matter of fact, this policy could eventually lead to
even more serious trouble.

It is entirely incomprehensible how the idea originates that

making the export of one’s own notes more difficult is an appro-
priate method for reducing the foreign exchange rate. If fewer

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 31

notes leave the country, then more commodities must be
exported or fewer imported. The quotation for notes on
exchange markets abroad does not depend on the greater or
lesser supplies of notes available there. Rather, it depends on
commodity prices. The fact that foreign speculators buy up notes
and hoard them, leading to a speculative boom, is only likely to
raise their quoted price. If the sums held by foreign speculators
had remained within the country, the domestic commodity
prices and, as a result, the “final rate” of foreign exchange would
have been driven up still higher.

If inflation continues, neither foreign exchange regulations

nor control of foreign exchange clearings can stop the deprecia-
tion of the monetary unit abroad.

VI.

NFLATIONIST

RGUMENT

1. S

UBSTITUTE FOR

AXES

Nowadays, the thesis is maintained that sound monetary rela-

tionships may certainly be worth striving for, but public policy is
said to have other higher and more important goals. As serious
an evil as inflation is, it is not considered the most serious. If it is
a choice of protecting the homeland from enemies, feeding the
starving and keeping the country from destruction, then let the
currency go to rack and ruin. And if the German people must pay
off a tremendous war debt, then the only way they can help them-
selves is through inflation.

This line of reasoning in favor of inflationism must be sharply

distinguished from the old inflationist argument which actually
approved of the economic consequences of continual monetary
depreciation and considered inflationism a worthwhile political
goal. According to the later doctrine, inflationism is still consid-
ered an evil although, under certain circumstances, a lesser evil.

32 — The Causes of the Economic Crisis

In its eyes, monetary depreciation is not considered the
inevitable outcome of a certain pattern of economic conditions,
as it is by adherents of the “balance of payments” doctrine dis-
cussed in the preceding section. Advocates of limited
inflationism tacitly, if not openly, admit in their argumentation
that paper money inflation, as well as the resulting monetary
depreciation, is always a product of inflationist policy. However,
they believe that a government may get into a situation in which
it would be more advantageous to counter a greater evil with the
lesser evil of inflationism.

The argument for limited inflationism is often stated so as to

represent inflationism as a kind of a tax which is called for under
certain conditions. In some situations it is considered more
advantageous to cover government expenditures by issuing new
notes, than by increasing the burden of taxes or borrowing
money. This was the argument during the war, when it was a
question of defraying the expenses of the army and navy. The
same argument is now advanced when it comes to supplying
some of the population with cheap foodstuffs, covering the oper-
ating deficits of public enterprises (the railroads, etc.) and
arranging for reparations payments. The truth is that inflation-
ism is resorted to when raising taxes is considered disagreeable
and when borrowing is considered impossible. The question now
is to explore the reasons why it is considered disagreeable or
impossible to employ these two normally routine ways of obtain-
ing money for government expenditures.

2. F

INANCING

NPOPULAR

XPENDITURES

High taxes can be imposed only if the general public is in

agreement with the purposes for which the funds collected will
be used. In this connection, it is worth noting that the higher the
general burden of taxes, the more difficult it becomes to deceive
public opinion as to the fact that the taxes cannot be borne by
the more affluent minority of the population alone. Even taxes
levied on property owners and the more affluent affect the entire
economy. Their indirect effects on the less well-to-do are often
felt more intensely than would be those from direct proportional

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 33

taxation. It may not be easy to detect these relationships when
tax rates are relatively low, but they can hardly be overlooked
when taxes are higher. However, there is no doubt that the pres-
ent system of taxing “property” can hardly be carried any farther
than it already has been in the countries where inflationism now
prevails. Thus the decision will have to be made to rely more
directly on the masses for providing funds. For policy makers
who enjoy the confidence of the masses only if they impose no
obvious sacrifice, this is something they dare not risk.

Can anyone doubt that the warring peoples of Europe would

have tired of the conflict much sooner, if their governments had
clearly, candidly, and promptly, presented them with the bill for
military expenses? No war party in any European country would
have dared to levy any considerable taxes on the masses to pay
the costs of the war. Even in England, the printing presses were
set in motion. Inflation had the great advantage of creating an
appearance of economic well-being, of an increase of wealth. It
also concealed capital consumption by falsifying monetary calcu-
lations. The inflation led to illusory entrepreneurial and
capitalistic profits, which could be taxed as income at especially
high rates. This could be done without the masses, and fre-
quently even without the taxpayers themselves, noticing that a
portion of capital itself was being taxed away. Inflation made it
possible to turn the anger of the people against “war profiteers,
speculators and smugglers.” Thus, inflation proved itself an excel-
lent psychological aid to the pro-war policy, leading to
destruction and annihilation.

What the war began, the revolution continues. A socialistic or

semi-socialistic government needs money to operate unprof-
itable enterprises, to subsidize the unemployed and to provide
the people with cheap food supplies. Yet, it cannot raise the funds
through taxes. It dares not tell the people the truth. The pro-sta-
tist, pro-socialist doctrine calling for government operation of
the railroads would lose its popularity very quickly if a special tax
were levied to cover the operating losses of the government rail-
roads. If the Austrian masses themselves had been asked to pay a

34 — The Causes of the Economic Crisis

special bread tax, they would very soon have realized from
whence came the funds to make the bread cheaper.

3. W

EPARATIONS

The decisive factor for the German economy is obviously the

payment of the reparations burden imposed by the Treaty of
Versailles and its supplementary agreements. According to Karl
Helfferich,

these payments imposed on the German people an

annual obligation estimated at two-thirds of their national income.
This figure is undoubtedly much too high. No doubt, other
estimates, especially those pronounced by French observers, con-
siderably underestimate the actual ratio. In any event, the fact
remains that a very sizeable portion of Germany’s current income
is consumed by the levy imposed on the nation, and that, if the
specified sum is to be withdrawn every year from income, the liv-
ing standard of the German people must be substantially reduced.

Even though somewhat hampered by the remnants of feudal-

ism, an authoritarian constitution and the rise of statism and
socialism, capitalism was able to develop to a considerable extent
on German soil. In recent generations, the capitalistic economic
system has multiplied German wealth many times over. In 1914,
the German economy could support three times as many people
as a hundred years earlier and still offer them incomparably more.
The war and its immediate consequences have drastically reduced
the living standards of the German people. Socialistic destruction
has continued this process of impoverishment. Even if the
German people did not have to fulfill any reparations payments,
they would still be much, much poorer than they were before the
war. The burden of these obligations must inevitably reduce their
living standard still further—to that of the thirties and forties of
the last century. It may be hoped that this impoverishment will

Karl Helfferich, Die Politik der Erfüllung (Munich, 1922), p. 22.

[NOTE: Helfferich (1872–1924), as Minister of the German Imperial
Treasury, 1915–1916, and later in various official and unofficial capaci-
ties, was instrumental in promoting inflation and opposing reparations
payments.—Ed.]

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 35

Thus, raising a foreign loan falls within this category too.

lead to a reexamination of the socialist ideology which dominates
the German spirit today, that this will succeed in removing the
obstacles now preventing an increase in productivity, and that the
unlimited opening up of possibilities for development, which exist
under capitalism and only under capitalism, will increase many
times over the output of German labor. Still the fact remains that
if the obligation assumed is to be paid for out of income, the only
way is to produce more and consume less.

A part of the burden, or even all of it, could of course be paid

off by the export of capital goods. Shares of stock, bonds,

busi-

ness assets, land, buildings, would have to be transferred from
German to foreign ownership. This would also reduce the total
income of the people in the future, if not right away.

4. T

LTERNATIVES

These various means, however, are the only ways by which the

reparations obligations can be met. Goods or capital, which
would otherwise have been consumed within the country, can be
exported. To discuss which is more practical is not the task of this
essay. The only question which concerns us is how the govern-
ment can proceed in order to shift to the individual citizens the
burden of payments, which devolves first of all on the German
treasury. Three ways are possible: raising taxes; borrowing within
the country; and issuing paper money. Whichever one of the
three methods may be chosen, the nature of its effect abroad
remains unaltered. These three ways differ only in their distribu-
tion of the burden among citizens.

If the funds are collected by raising a domestic loan, then sub-

scribers to the loan must either reduce their consumption or
dispose of a part of their capital. If taxes are imposed, then the
taxpayers must do the same. The funds which flow from taxes or
loans into the government treasury and which it uses to buy gold,
foreign bills of exchange and foreign currencies to fulfill its for-
eign liabilities, are supplied by the lenders and the taxpayers

36 — The Causes of the Economic Crisis

through the sale abroad of commodities and capital goods. The
government can only purchase available foreign exchange which
comes into the country from these sales. So long as the govern-
ment has the power to distribute only those funds which it
receives from tax payments and the floating of loans, its pur-
chases of foreign exchange cannot push up the price of gold and
foreign currencies. At any one time, the government can buy only
so much gold and foreign exchange as the citizens have acquired
through export sales. In fact, the world prices of goods and serv-
ices cannot rise on this account. Rather their prices will decline
as a consequence of the larger quantities offered for sale.

However, if and as the government follows the third route,

issuing new notes in order to buy gold and foreign exchange
instead of raising taxes and floating loans, then its demand for
gold and foreign exchange, which is obviously not counterbal-
anced by a proportionate supply, drives up the prices of various
kinds of foreign money. It then becomes advantageous for for-
eigners to acquire more marks so as to buy capital goods and
commodities within Germany at prices which do not yet reflect
the new ratios. These purchases drive prices up in Germany right
away and bring them once again into adjustment with the world
market. This is the actual situation. The foreign exchange, with
which reparations obligations are paid, comes from sales abroad
of German capital and commodities. The only difference consists
in how the government obtains the foreign exchange. In this case,
the government first buys the foreign exchange abroad with
marks, which the foreigners then use to make purchases in
Germany, rather than the German government’s acquiring the
foreign exchange from those within Germany who have received
payment for previous sales abroad.

From this one learns that the continuing depreciation of the

German mark cannot be the consequence of reparations pay-
ments. The depreciation of the mark is simply a result of the fact
that the government supplies the funds needed for the payments
through new issues of notes. Even those who wish to attribute the
decline in the rate of exchange on the market to the payment of
reparations, rather than to inflation, point out that the quotation

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 37

See Walter Rathenau’s addresses—January 12, 1922, before the Senate of

the Allied Powers at Cannes, and March 29, 1922, to the Reichstag (Cannes
und Genua, Vier Reden zum Reparationsproblem [Berlin 1922], pp. 11ff. and
34ff.). [NOTE: Rathenau (1867–1922), a German industrialist, became an
official in the post-World War I German government—Minister of
Reconstruction (1921) and Foreign Minister (1922).—Ed.]

for marks is inevitably disturbed by the government’s offering of
marks for the purchase of foreign exchange.

Still, if the govern-

ment had available for these foreign exchange purchases only the
number of marks which it received from taxes or loans, then its
demand would not exceed the supply. It is only because it is offer-
ing newly created notes, that it drives the foreign exchange rates
up.

5. T

OVERNMENT

’

ILEMMA

Nevertheless, this is the only method available for the German

government to defray the reparations debt. Should it try to raise the
sums demanded through loans or taxes, it would fail. As conditions
with the German people are now, if the economic consequences of
compliance were clearly understood and there was no deception as
to the costs of that policy, the government could not count on
majority support for it. Public opinion would turn with tremendous
force against any government that tried to carry out in full the obli-
gations to the Allied Powers. It is not our task to explore whether or
not that might be a wise policy.

However, saying that the decline of the value of the German

mark is not the direct consequence of making reparations pay-
ments but is due rather to the methods the German government
uses to collect the funds for the payments, by no means has the
significance attached to it by the French and other foreign politi-
cians. They maintain that it is justifiable, from the point of view
of world policy, to burden the German people with this heavy
load. This explanation of the German monetary depreciation has
absolutely nothing to do with whether, in view of the terms of the
Armistice, the Allied demand, in general, and its height, in par-
ticular, are founded on justice.

38 — The Causes of the Economic Crisis

The only significant thing for us, however, since it explains the

political role of the inflationist procedure, is yet another insight.
We have seen that if a government is not in a position to negotiate
loans and does not dare levy additional taxation for fear that the
financial and general economic effects will be revealed too clearly
too soon, so that it will lose support for its program, it always con-
siders it necessary to undertake inflationary measures. Thus
inflation becomes one of the most important psychological aids to
an economic policy which tries to camouflage its effects. In this
sense, it may be described as a tool of antidemocratic policy. By
deceiving public opinion, it permits a system of government to
continue which would have no hope of receiving the approval of
the people if conditions were frankly explained to them.

Inflationist policy is never the necessary consequence of a

specific economic situation. It is always the product of human
action—of man-made policy. For whatever the reason, the quan-
tity of money in circulation is increased. It may be that the people
are influenced by incorrect theoretical doctrines as to the way the
value of money develops and are not aware of the consequences
of this action. It may be that, in full knowledge of the effects of
inflation, they are purposely aiming, for some reason, at a reduc-
tion in the value of the monetary unit. So no apology can ever be
given for inflationist policy. If it rests on theoretically incorrect
monetary doctrines, then it is inexcusable, for there should never,
never be any forgiveness for wrong theories. If it rests on a defi-
nite judgment as to the effects of monetary depreciation, then to
want to “excuse it” is inconsistent. If monetary depreciation has
been knowingly engineered, its advocates would not want to
excuse it but rather to try to demonstrate that it was a good pol-
icy. They would want to show that, under the circumstances, it
was even better to depreciate the money than to raise taxes fur-
ther or to permit the deficit-ridden, nationalized railroads to be
transferred from government control to private hands.

Even governments must learn once more to adjust their outgo

to income. Once the end results to which inflation must lead are
recognized, the thesis, that a government is justified in issuing

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 39

notes to make up for its lack of funds, will disappear from the
handbooks of political strategy.

VII.

ONETARY

YSTEM

1. F

IRST

TEPS

The bedrock and cornerstone of the provisional new mone-

tary system must be the absolute prohibition of the issue of any
additional notes not completely covered by gold. The maximum
limit for German notes in circulation [not completely covered by
gold] will be the sum of the banknotes, Loan Bureau Notes
(Darlehenskassenscheinen), emergency currency (Notgeld) of
every kind, and small coins, actually in circulation at the instant
of the monetary reform, less the gold stock and supply of foreign
bills held in the reserves of the Reichsbank and the private banks
of issue. There must be absolutely no expansion above this max-
imum under any circumstances, except for the relaxation
mentioned above at the end of each quarter. [See above pp.
29–30.] Notes of any kind over and above this amount must be
fully covered by deposits of gold or foreign exchange in the
Reichsbank. As may be seen, this constitutes acceptance of the
leading principle of Peel’s Bank Act, with all its shortcomings.
However, these flaws have little significance at the moment. Our
first concern is only to get rid of the inflation by stopping the
printing presses. This goal, the only immediate one, will be most
effectively served by a strict prohibition of the issue of additional
notes not backed by metal.

Once adjustments have been made to the new situation, then

it will be time enough to consider:

(1) On the one hand, whether it might not perhaps be expe-

dient to tolerate the issue, within very narrow limits, of
notes not covered by metal.

40 — The Causes of the Economic Crisis

(2) On the other hand, whether it might not also be neces-

sary to limit similarly the issue of other fiduciary media
by establishing regulations over the banks’ cash balances
and their check and draft transactions.

The question of banking freedom must then be discussed,

again and again, on basic principles. Still, all this can wait until
later. What is needed now is only to prohibit the issue of addi-
tional notes not covered by metal. This is all that can be done at
present. Ideally, the limitation on the issue of currency could also
be extended, even now, to the Reichsbank’s transfer balances
(deposits).

However, this is not of as critical importance, for the

present currency inflation has been and can be brought about
only by the issue of notes.

Simultaneously with the enactment of the prohibition against

the issue of additional notes not covered by metal, the Reichsbank
should be required to purchase all supplies of gold offered them in
exchange for notes at prices precisely corresponding to the new
ratio. At the same time, the Reichsbank should be obliged to supply
any amount of gold requested at that ratio, to anyone able to offer
German notes in payment. With this reform, the German standard
would become a gold exchange standard (Goldkernwährung). Later
will be time enough to examine whether or not to renounce perma-
nently the actual circulation of gold within the country. Careful
consideration should be given to whether or not the higher costs
needed to maintain the actual circulation of gold within the coun-
try might not be amply repaid by the fact that this would permit the
people to discontinue using notes. Weaning the people away from
paper money could perhaps forestall future efforts aimed at the
over-issue of notes endowed with legal tender status. Nevertheless,
the gold exchange standard is undoubtedly sufficient for the time

See p. 26 above. [NOTE: The German term is “Giroguthaben.” In

Germany the “giro” banking system prevailed whereby depositors, instead
of writing checks, authorized their banks to transfer specified sums to the
accounts they wished paid.—Ed.]

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 41

[In view of Mises’s comments here, it appears that he then intended

that the Reichsbank redeem at this point only larger sums of marks in gold
and foreign exchange. Mises’s insistence in later years on a gold coin stan-
dard, with gold coins in daily use, even in the early stages of monetary
reform, represents a significant refinement of these earlier recommenda-
tions. See Human Action, chapter XXXI, section 3, and his 1953 essay,
“Monetary Reconstruction,” the Epilogue to The Theory of Money and
Credit, 1953, pp. 448–52; 1980, pp. 490–95. Also above, p. 20, note 14.—Ed.]

[In The Theory of Money and Credit (1953, pp. 377ff.; 1980, pp. 416ff.),

Mises describes the “gold premium policy” of making it difficult and expen-
sive to obtain gold—by hampering its export through the manipulation of
discount rates and by limiting the redemption of domestic money in gold.
—Ed.]

being.

The legal rate for notes in making payments can be tem-

porarily maintained without risk.

It should also be specifically pointed out that the obligation

of the Reichsbank to redeem its notes must be interpreted in
the strictest possible manner. Every subterfuge, by which
European central banks sought to follow some form of “gold
premium policy”

during the decades preceding the World

War, must be discontinued.

2. M

ARKET

NTEREST

ATES

If the Reichsbank were operating under these principles, it

would obviously not be in a position to supply the money market
with funds obtained by increasing the circulation of notes not
covered by metal. Except for the possibilities of such transfers as
may not have been previously limited, the Bank will be able to
lend out only its own resources and funds furnished by its credi-
tors. Inflationary increases in the note circulation for the benefit
of private, as well as public, credit demands will thus be ruled
out. The Bank will not then be in a position to follow the policy—
which it has attempted again and again—of lowering artificially
the market rate of interest.

The explanation of the balance of payments doctrine pre-

sented here shows that under this arrangement the Reichsbank
would not run the risk of an outflow of its gold and foreign

42 — The Causes of the Economic Crisis

[Apparently works of Friedrich Bendixen (1864–1920) are not available

in English language translations.—Ed.]

exchange (Devisen) holdings. Citizens lacking confidence in
future banking policy, who in the early years of the new monetary
system try to exchange notes for gold or foreign exchange
(Devisen), will not be satisfied with the assertion that the Bank
will be required to redeem its notes only in larger sums, for gold
bars and foreign exchange, not for gold coins. Then it will not be
possible to eliminate all notes from circulation. In the beginning
a larger amount [of foreign currencies and metallic money] may
even be withdrawn from the Bank and hoarded. However, as
soon as some confidence in the reliability of the new money
develops, the hoards of foreign moneys and gold accumulated
will flow into the Bank.

The Reichsbank must renounce every attempt to lower inter-

est rates below those which reflect the actual supply and demand
relationships existing in the capital markets, and thus encourage
the demand for loans which can only be made by increasing the
quantity of notes. This prerequisite for monetary reform will
evoke the criticism of the naïve inflationists of the business
world. These criticisms will grow as the difficulties of providing
credit for the German economy increase during the coming
years. In the view of the businessman, the role of the central bank
of issue is to provide cheap credit. The businessman believes that
the Bank should not deny newly created notes to those who want
additional credit. For decades, the errors of the English Banking
School theoreticians have prevailed in Germany. Bendixen has
recently made them popular through his easily readable Theorie
der klassischen Geldschöpfung.

People keep forgetting that the increase in the cost of credit—

which has become known by the very misleading term, “scarcity
of money”—cannot be overcome in the long run by inflationist
measures. They also forget that the interest rate cannot be
reduced in the long run by credit expansion. The expansion of
credit always leads to higher commodity prices and quotations
for foreign exchange and foreign moneys.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 43

[In his later works, Mises would have covered all these ideas, except

“socialism,” with the terms “interventionism” or “hampered market.”—Ed.]

VIII.

DEOLOGICAL

EANING OF

EFORM

1. T

DEOLOGICAL

ONFLICT

The purely materialistic doctrine now used to explain every

event looks on monetary depreciation as a phenomenon brought
about by certain “material” causes. Attempts are made to coun-
teract these imagined causes by various monetary techniques.
People ignore, perhaps knowingly, that the roots of monetary
depreciation are ideological in nature. It is always an inflationist
policy, not “economic conditions,” which brings about the mone-
tary depreciation. The evil is philosophical in character. The state
of affairs, universally deplored today, was created by a misunder-
standing of the nature of money and an incorrect judgment as to
the consequences of monetary depreciation.

Inflationism, however, is not an isolated phenomenon. It is

only one piece in the total framework of politico-economic and
socio-philosophical ideas of our time. Just as the sound money
policy of gold standard advocates went hand in hand with liber-
alism, free trade, capitalism and peace, so is inflationism part and
parcel of imperialism, militarism, protectionism, statism and
socialism.

Just as the world catastrophe, which has swept over

mankind since 1914, is not a natural phenomenon but the neces-
sary outcome of the ideas which dominate our time, so also is the
monetary crisis nothing but the inevitable consequence of the
supremacy of certain ideologies concerning monetary policy.

Statist Theory has tried to explain every social phenomenon

by the operation of mysterious power factors. It has disputed
the possibility that economic laws for the formation of prices
could be demonstrated. Failing to recognize the significance of

44 — The Causes of the Economic Crisis

commodity prices for the development of exchange relationships
among various moneys, it has tried to distinguish between the
domestic and foreign values of money. It has tried to attribute
changes in exchange rates to various causes—the balance of pay-
ments, speculative activity, and political factors. Ignoring
completely the Currency Theory’s important criticism of the
Banking Theory, Statist Theory has actually prescribed the
Banking Theory. It has moreover even revived the doctrine of the
canonists and of the legal authorities of the Middle Ages to the
effect that money is a creature of the government and the legal
order. Thus, Statist Theory prepared the philosophical ground-
work from which the inflationism of recent years developed.

The belief that a sound monetary system can once again be

attained without making substantial changes in economic policy
is a serious error. What is needed first and foremost is to
renounce all inflationist fallacies. This renunciation cannot last,
however, if it is not firmly grounded on a full and complete
divorce of ideology from all imperialist, militarist, protectionist,
statist, and socialist ideas.

PPENDIX

ALANCE OF

AYMENTS

AND

OREIGN

XCHANGE

ATES

The printing press played an important role in creating the

means for carrying on the war. Every belligerent nation and many
neutral ones used it. With the cessation of hostilities, however, no
halt was called to the money-creating activities of the banks of
issue. Previously, notes were printed to finance the war. Today,

Originally published as “Zahlungsbilanz und Devisenkurse” in

Mitteilungen des Verbandes Oesterreichischer Banken und Bankiers 2, nos.
3–4 (1919). This translated excerpt represents about one-third of the orig-
inal article.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 45

notes are still being printed, at least in some countries, to satisfy
domestic demands of various kinds. The entire world is under
the sway of inflation. The prices of all goods and services rise
from day to day and no one can say when these increases will
come to an end.

Inflation today is a general phenomenon, but its magnitude is

not the same in every country. The increase in the quantity of
money in the different currency areas is neither equal statisti-
cally—an equality which, given the different demands for money
in the different areas, would be apparent only—nor has the
increase proceeded in all areas in the same ratio to the demand for
money. Thus, price increases, insofar as they are due to changes
from the money side, have not been the same everywhere. . . .

Price increases, which are called into existence by an increase in

the quantity of money, do not appear overnight. A certain amount
of time passes before they appear. The additional quantity of
money enters the economy at a certain point. It is only from there,
step by step, that it is dispersed. It goes first to certain individuals
in the economy only and to certain branches of production. As a
result, in the beginning it raises the demand for certain goods and
services only, not for all of them. Only later do the prices of other
goods and services also rise. Foreign exchange quotations, how-
ever, are speculative rates of exchange—that is, they arise out of the
transactions of business people, who, in their operations, consider
not only the present but also potential future developments. Thus,
the depreciation of the money becomes apparent relatively soon in
the foreign exchange quotations on the Bourse—long before the
prices of other goods and services are affected. . . .

Now, there is one theory which seeks to explain the formation

of foreign exchange rates by the balance of payments, rather than
by a currency’s purchasing power. This theory makes a distinction
in the depreciation of the money between the decline in the cur-
rency’s value on international markets and the reduction in its
purchasing power domestically. It maintains that there is only a
very slight connection between the two or, as many say, no con-
nection at all. The exchange rate of foreign currencies is a result
of the momentary balance of payments. If the payments going

46 — The Causes of the Economic Crisis

abroad rise without a corresponding increase in the payments
coming into the country, or if the payments coming from abroad
should decline without a corresponding reduction of the pay-
ments going out of the country, then foreign exchange rates must
rise.

We shall not speculate on the reasons why such a theory can

be advanced. Between the change in the exchange rates for for-
eign currencies and the change in the monetary unit’s domestic
purchasing power, there is usually a time lag—shorter or longer.
Therefore, superficial observation could very easily lead to the
conclusion that the two data were independent of one another.
We have also heard that the balance of payments is the immedi-
ate cause of the daily fluctuations in exchange rates. A theory
which explained surface appearances only and did not analyze
the situation thoroughly could easily overlook the facts that (a)
the day-to-day ratio between the supply of and demand for for-
eign exchange determined by the balance of payments can evoke
only transitory variations from the “static” rate formed by the
purchasing power of various kinds of money, (b) these deviations
must disappear promptly, and (c) these variations will vanish
more quickly and more completely the less restraints are
imposed on trade and the freer speculation is.

Certainly there shouldn’t be any reason to examine this the-

ory further. It has been settled scientifically. The fact that it
plays a significant role in economic policy may be a reason for
investigating the political basis for its undoubted popularity
among government officials and writers. Still that may be left to
others.

However, we must concern ourselves with a new variety of this

balance of payments doctrine which originated with the war.
People say it may be generally true that the purchasing power of
the money, rather than the balance of payments, determines the
exchange rate of foreign currencies. But now, in view of the reduc-
tion of trade brought about by the war, this is not the case. Since
trade is hampered, the process which would restore the disrupted
“static” exchange ratios among foreign currencies is held in check.
As a result, therefore, the balance of payments becomes decisive

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 47

For the sake of completeness only, it should be mentioned that the

adherents of this theory attribute domestic price increases, not to the infla-
tion, but to the shortage of goods exclusively.

for the exchange rates of foreign currencies.

If it is desired to raise

the foreign exchange rate, or to keep it from declining further, one
must try to establish a favorable balance of payments. . . .

The basic fallacy in this theory is that it completely ignores the

fact that the height of imports and exports depends primarily on
prices. Neither imports nor exports are undertaken out of
caprice or just for fun. They are undertaken to carry on a prof-
itable trade, that is to earn money from the differences in prices
on either side. Thus imports or exports are carried on until price
differences disappear. . . .

The balance of payments doctrine of foreign exchange rates

completely overlooks the meaning of prices for the international
movement of goods. It proceeds erroneously from the act of pay-
ment, instead of from the business transaction itself. That is a
result of the pseudo-legal monetary theory—a theory which has
brought the most cruel consequences to German science—the
theory which looks on money as a means of payment only, and
not as a general medium of exchange.

When deciding to undertake a business transaction, a mer-

chant does not ignore the costs of obtaining the necessary foreign
currency until the time when the payment actually comes due. A
merchant who proceeded in this way would not long remain a
merchant. The merchant takes the ratio of foreign currency very
much into account in his calculations, as he always has an eye to
the selling price. Also, whether he hedges against future changes
in the exchange rate, or whether he bears the risk himself of shifts
in foreign currency values, he considers the anticipated fluctua-
tions in foreign exchange. The same situation prevails mutatis
mutandis with reference to tourist traffic and international
freight. . . .

48 — The Causes of the Economic Crisis

It is easy to recognize that we find here only a new form of the

old favorable and unfavorable balance of trade theory champi-
oned by the Mercantilist School of the sixteenth to eighteenth
centuries. That was before the widespread use of banknotes and
other bank currency. The fear was then expressed that a country
with an unfavorable balance of trade could lose its entire supply
of the precious metals to other lands. Therefore, it was held that
by encouraging exports and limiting imports so far as possible, a
country could take precautions to prevent this from happening.
Later, the idea developed that the trade balance alone was not
decisive, that it was only one factor in creating the balance of pay-
ments and that the entire balance of payments must be
considered. As a result, the theory underwent a partial reorgani-
zation. However, its basic tenet—namely that when a government
did not control its foreign trade relations, all its precious metals
might flow abroad—persisted until it lost out finally to the hard-
hitting criticism of Classical economics.

The balance of payments of a country is nothing but the sum

of the balances of payments of all its individual enterprises. The
essence of every balance is that the debit and credit sides are
equal. If one compares the credit entries and the debit entries of
an enterprise the two totals must be in balance. The situation can
be no different in the case of the balance of payments of an entire
country. Then too, the totals must always be in balance. This
equilibrium, that must necessarily prevail because goods are
exchanged—not given away—in economic trading, is not
brought about by undertaking all exports and imports first, with-
out considering the means of payment, and then only later
adjusting the balance in money. Rather, money occupies precisely
the same position in undertaking a transaction as do the other
commodities being exchanged. Money may even be the usual
reason for making exchanges.

In a society in which commodity transactions are monetary

transactions, every individual enterprise must always take care to
have on hand a certain quantity of money. It must not permit its
cash holding to fall below the definite sum considered necessary
for carrying out its transactions. On the other hand, an enterprise

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 49

See Hertzka, Das Wesen des Geldes (Leipzig, 1887), pp. 44ff.; Wieser,

“Der Geldwert und seine Veränderungen,” Schriften des Vereins für
Sozialpolitik 132 (Leipzig, 1910): 530ff.

will not permit its cash holding to exceed the necessary amount,
for allowing that quantity of money to lie idle will lead to loss of
interest. If it has too little money, it must reduce purchases or sell
some wares. If it has too much money, then it must buy goods.

For our purposes here, it is immaterial whether the enterprise

buys producers’ or consumers’ goods. In this way, every individ-
ual sees to it that he is not without money. Because everyone
pursues his own interest in doing this, it is impossible for the free
play of market forces to cause a drain of all money out of a city, a
province or an entire country. The government need not concern
itself with this problem any more than does the city of Vienna
with the loss of its monetary stock to the surrounding country-
side. Nor—assuming a precious metals standard (the purely
metallic currency of the English Currency School)—need gov-
ernment concern itself with the possibility that the entire
country’s stock of precious metals will flow out.

If we had a pure gold standard, therefore, the government

need not be in the least concerned about the balance of pay-
ments. It could safely relinquish to the market the responsibility
for maintaining a sufficient quantity of gold within the country.
Under the influence of free trade forces, precious metals would
leave the country only if a surplus was on hand and they would
always flow in if too little was available, in the same way that all
other commodities are imported if in short supply and exported
if in surplus. Thus, we see that gold is constantly moving from
large-scale gold producing countries to those in which the
demand for gold exceeds the quantity mined—without the need
for any government action to bring this about

. . . .

It may be asked, however, doesn’t history show many examples

of countries whose metallic money (gold and silver) has flown
abroad? Didn’t gold coins disappear from the market in Germany
just recently? Didn’t the silver coins vanish here at home in Austria?

50 — The Causes of the Economic Crisis

Isn’t this evidence a clear-cut contradiction of the assertion that
trade spontaneously maintains the monetary stock? Isn’t this proof
that the state needs to interfere in the balance of payments?

However, these facts do not in the least contradict our state-

ment. Money does not flow out because the balance of payments
is unfavorable and because the state has not interfered. Rather,
money flows out precisely because the state has intervened and
the interventions have called forth the phenomenon described by
the well-known Gresham’s Law. The government itself has
ruined the currency by the steps it has taken. And then the gov-
ernment tries in vain, by other measures, to restore the currency
it has ruined.

The disappearance of gold money from trade follows from the

fact that the state equates, in terms of legal purchasing power, a
lesser-valued money with a higher-valued money. If the govern-
ment introduces into trade quantities of inconvertible banknotes
or government notes, then this must lead to a monetary depreci-
ation. The value of the monetary unit declines. However, this
depreciation in value can affect only the inconvertible notes.
Gold money retains all, or almost all, of its value internationally.
However, since the state—with its power to use the force of law—
declares the lower-valued monetary notes equal in purchasing
power to the higher-valued gold money and forbids the gold
money from being traded at a higher value than the paper notes,
the gold coins must vanish from the market. They may disappear
abroad. They may be melted down for use in domestic industry.
Or they may be hoarded. That is the phenomenon of good money
being driven out by bad, observed so long ago by Aristophanes,
which we call Gresham’s Law.

No special government intervention is needed to retain the

precious metals in circulation within a country. It is enough for
the state to renounce all attempts to relieve financial distress by
resorting to the printing press. To uphold the currency, it need do
no more than that. And it need do only that to accomplish this
goal. All orders and prohibitions, all measures to limit foreign
exchange transactions, etc., are completely useless and purpose-
less.

If we had a pure gold standard, measures to prevent a gold

outflow from the country due to an unfavorable balance of pay-
ments would be completely superfluous. He who has no money
to buy abroad, because he has neither exported goods nor per-
formed services abroad, will be able to buy abroad only if
foreigners give him credit. However, his foreign purchases then
will in no way disturb the stability of the domestic currency.

Stabilization of the Monetary Unit—From the Viewpoint of Theory — 51

n recent years the problems of monetary and banking policy
have been approached more and more with a view to both
stabilizing the value of the monetary unit and eliminating

fluctuations in the economy. Thanks to serious attempts at
explaining and publicizing these most difficult economic prob-
lems, they have become familiar to almost everyone. It may
perhaps be appropriate to speak of fashions in economics, and it
is undoubtedly the “fashion” today to establish institutions for the
study of business trends.

This has certain advantages. Careful attention to these prob-

lems has eliminated some of the conflicting doctrines which had
handicapped economics. There is only one theory of monetary
value today—the Quantity Theory. There is also only one trade
cycle theory—the Circulation Credit Theory, developed out of
the Currency Theory and usually called the “Monetary Theory of
the Trade Cycle.” These theories, of course, are no longer what
they were in the days of Ricardo and Lord Overstone. They have
been revised and made consistent with modern subjective eco-
nomics. Yet the basic principle remains the same. The underlying
thesis has merely been elaborated upon. So despite all its defects,
which are now recognized, due credit should be given the
Currency School for its achievement.

Geldwertstabilisierung und Konjunkturpolitik (Jena: Gustav Fischer, 1928).

ONETARY

TABILIZATION AND

YCLICAL

OLICY

(1928)

In this connection, just as in all other aspects of economics, it

becomes apparent that scientific development goes steadily for-
ward. Every single step in the development of a doctrine is
necessary. No intellectual effort applied to these problems is in
vain. A continuous, unbroken line of scientific progress runs
from the Classical authors down to the modern writers. The
accomplishment of Gossen, Menger, Walras, and Jevons, in over-
coming the apparent antinomy of value during the third quarter
of the last century, permits us to divide the history of economics
into two large subdivisions—the Classical, and the Modern or
Subjective. Still it should be remembered that the contributions
of the Classical School have not lost all value. They live on in
modern science and continue to be effective.

Whenever an economic problem is to be seriously considered,

it is necessary to expose the violent rejection of economics which
is carried on everywhere for political reasons, especially on
German soil. Nothing concerning the problems involved in either
the creation of the purchasing power of money or economic fluc-
tuations can be learned from Historicism or Nominalism.
Adherents of the Historical-Empirical-Realistic School and of
Institutionalism either say nothing at all about these problems, or
else they depend on the very same methodological and theoreti-
cal grounds which they otherwise oppose. The Banking Theory,
until very recently certainly the leading doctrine, at least in
Germany, has been justifiably rejected. Hardly anyone who
wishes to be taken seriously dares to set forth the doctrine of the
elasticity of the circulation of fiduciary media—its principal the-
sis and cornerstone.

54 — The Causes of the Economic Crisis

Sixteen years ago when I presented the circulation credit theory of the

crisis in the first German edition of my book on The Theory of Money and
Credit (1912); [English editions, New London, Conn.: Yale University
Press, 1953; Indianapolis, Ind.: LibertyClassics, 1980], I encountered igno-
rance and stubborn rejection everywhere, especially in Germany. The
reviewer for Schmoller’s Yearbook [Jahrbuch für Gesetzgebung, Verwaltung
und Volkswirtschaft] declared: “The conclusions of the entire work [are]
simply not discussable.” The reviewer for Conrad’s Yearbook [Jahrbuch für

However, the popularity attained by the two political prob-

lems of stabilization—the value of the monetary unit and
fiduciary media—also brings with it serious disadvantages. The
popularization of a theory always contains a threat of distorting
it, if not of actually demolishing its very essence. Thus the results
expected of measures proposed for stabilizing the value of the
monetary unit and eliminating business fluctuations have been
very much overrated. This danger, especially in Germany, should
not be underestimated. During the last ten years, the systematic
neglect of the problems of economic theory has meant that no
attention has been paid to accomplishments abroad. Nor has any
benefit been derived from the experiences of other countries.

The fact is ignored that proposals for the creation of a mone-

tary unit with “stable value” have already had a hundred year
history. Also ignored is the fact that an attempt to eliminate eco-
nomic crises was made more than eighty years ago—in
England—through Peel’s Bank Act (1844). It is not necessary to
put all these proposals into practice to see their inherent difficul-
ties. However, it is simply inexcusable that so little attention has
been given during recent generations to the understanding
gained, or which might have been gained if men had not been so
blind, concerning monetary policy and fiduciary media.

Current proposals for a monetary unit of “stable value” and for

a nonfluctuating economy are, without doubt, more refined than
were the first attempts of this kind. They take into consideration
many of the less important objections raised against earlier proj-
ects. However, the basic shortcomings, which are necessarily
inherent in all such schemes, cannot be overcome. As a result,
the high hopes for the proposed reforms must be frustrated.

Monetary Stabilization and Cyclical Policy — 55

Nationalökonomie und Statistik] stated: “Hypothetically, the author’s argu-
ments should not be described as completely wrong; they are at least
coherent.” But his final judgment was “to reject it anyhow.” Anyone who fol-
lows current developments in economic literature closely, however, knows
that things have changed basically since then. The doctrine which was
ridiculed once is widely accepted today.

If we are to clarify the possible significance—for economic sci-

ence, public policy and individual action—of the cyclical studies
and price statistics so widely and avidly pursued today, they must
be thoroughly and critically analyzed. This can, by no means, be
limited to considering cyclical changes only. “A theory of crises,”
as Böhm-Bawerk said,

can never be an inquiry into just one single phase of eco-
nomic phenomena. If it is to be more than an amateurish
absurdity, such an inquiry must be the last, or the next to
last, chapter of a written or unwritten economic system.
In other words, it is the final fruit of knowledge of all eco-
nomic events and their interconnected relationships.

Only on the basis of a comprehensive theory of indirect

exchange, i.e., a theory of money and banking, can a trade cycle
theory be erected. This is still frequently ignored. Cyclical theo-
ries are carelessly drawn up and cyclical policies are even more
carelessly put into operation. Many a person believes himself
competent to pass judgment, orally and in writing, on the prob-
lem of the formulation of monetary value and the rate of interest.
If given the opportunity—as legislator or manager of a country’s
monetary and banking policy—he feels called upon to enact rad-
ical measures without having any clear idea of their
consequences. Yet, nowhere is more foresight and caution neces-
sary than precisely in this area of economic knowledge and
policy. For the superficiality and carelessness, with which social
problems are wont to be handled, soon misfire if applied in this
field. Only by serious thought, directed at understanding the
interrelationship of all market phenomena, can the problems we
face here be satisfactorily solved.

56 — The Causes of the Economic Crisis

Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung VII, p. 132.

ART

TABILIZATION OF THE

URCHASING

OWER OF THE

ONETARY

NIT

ROBLEM

1. “S

TABLE

ALUE

” M

ONEY

old and silver had already served mankind for thousands of

years as generally accepted media of exchange—that is, as money—
before there was any clear idea of the formation of the exchange
relationship between these metals and consumers’ goods, i.e.,
before there was an understanding as to how money prices for
goods and services are formed. At best, some attention was given to
fluctuations in the mutual exchange relationships of the two pre-
cious metals. But so little understanding was achieved that men
clung, without hesitation, to the naïve belief that the precious met-
als were “stable in value” and hence a useful measure of the value of
goods and prices. Only much later did the recognition come that
supply and demand determine the exchange relationship between
money, on the one hand, and consumers’ goods and services, on the
other. With this realization, the first versions of the Quantity
Theory, still somewhat imperfect and vulnerable, were formulated.
It was known that violent changes in the volume of production of
the monetary metals led to all-round shifts in money prices. When
“paper money” was used along side “hard money,” this connection
was still easier to see. The consequences of a tremendous paper
inflation could not be mistaken.

From this insight, the doctrine of monetary policy emerged that

the issue of “paper money” should be avoided completely.
However, before long other authors made still further stipulations.
They called the attention of politicians and businessmen to the
fluctuations in the purchasing power of the precious metals and

Monetary Stabilization and Cyclical Policy — 57

proposed that the substance of monetary claims be made inde-
pendent of these variations. Side by side with money as the
standard of deferred payments,

or in place of it, there should be

a tabular, index, or multiple commodity standard. Cash transac-
tions, in which the terms of both sides of the contract are fulfilled
simultaneously, would not be altered. However, a new procedure
would be introduced for credit transactions. Such transactions
would not be completed in the sum of money indicated in the
contract. Instead, either by means of a universally compulsory
legal regulation or else by specific agreement of the two parties
concerned, they would be fulfilled by a sum with the purchasing
power deemed to correspond to that of the original sum at the
time the contract was made. The intent of this proposal was to
prevent one party to a contract from being hurt to the other’s
advantage. These proposals were made more than one hundred
years ago by Joseph Lowe (1822) and repeated shortly thereafter
by G. Poulett Scrope (1833).

Since then, they have cropped up

repeatedly but without any attempt having been made to put
them into practice anywhere.

2. R

ECENT

ROPOSALS

One of the proposals, for a multiple commodity standard, was

intended simply to supplement the precious metals standard.
Putting it into practice would have left metallic money as a univer-
sally acceptable medium of exchange for all transactions not
involving deferred monetary payments. (For the sake of simplicity
in the discussion that follows, when referring to metallic money we
shall speak only of gold.) Side by side with gold as the universally

58 — The Causes of the Economic Crisis

[In the German text Mises uses the English term, “Standard of deferred

payments,” commenting in a footnote: “Standard of deferred payments is
‘Zahlungsmittel’ in German. Unfortunately this German expression must
be avoided nowadays. Its meaning has been so compromised through its
use by Nominalists and Chartists that it brings to mind the recently
exploded errors of the state theory of money.” See above for comments on
“state theory of money,” p. 12, n. 9, and “chartism,” p. 20, n. 15.— Ed.]

William Stanley Jevons, Money and the Mechanism of Exchange, 13th

ed. (London, 1902), pp. 328ff.

acceptable medium of exchange, the index or multiple commodity
standard would appear as a standard of deferred payments.

Proposals have been made in recent years, however, which go

still farther. These would introduce a “tabular,” or “multiple com-
modity,” standard for all exchanges when one commodity is not
exchanged directly for another. This is essentially Keynes’s pro-
posal. Keynes wants to oust gold from its position as money. He
wants gold to be replaced by a paper standard, at least for trade
within a country’s borders. The government, or the authority
entrusted by the government with the management of monetary
policy, should regulate the quantity in circulation so that the pur-
chasing power of the monetary unit would remain unchanged.

The American, Irving Fisher, wants to create a standard under

which the paper dollar in circulation would be redeemable, not in
a previously specified weight of gold, but in a weight of gold which
has the same purchasing power the dollar had at the moment of
the transition to the new currency system. The dollar would then
cease to represent a fixed amount of gold with changing purchas-
ing power and would become a changing amount of gold
supposedly with unchanging purchasing power. It was Fisher’s
idea that the amount of gold which would correspond to a dollar
should be determined anew from month to month, according to
variations detected by the index number.

Thus, in the view of

both these reformers, in place of monetary gold, the value of
which is independent of the influence of government, a standard
should be adopted which the government “manipulates” in an
attempt to hold the purchasing power of the monetary unit stable.

However, these proposals have not as yet been put into prac-

tice anywhere, although they have been given a great deal of
careful consideration. Perhaps no other economic question is
debated with so much ardor or so much spirit and ingenuity in
the United States, as that of stabilizing the purchasing power of

Monetary Stabilization and Cyclical Policy — 59

John Maynard Keynes, A Tract on Monetary Reform (London, 1923;

New York, 1924), pp. 177ff.

Irving Fisher, Stabilizing the Dollar (New York, 1925), pp. 79ff.

the monetary unit. Members of the House of Representatives
have dealt with the problem in detail. Many scientific works are
concerned with it. Magazines and daily papers devote lengthy
essays and articles to it, while important organizations seek to
influence public opinion in favor of carrying out Fisher’s ideas.

II.

OLD

TANDARD

1. T

EMAND FOR

ONEY

Under the gold standard, the formation of the value of the

monetary unit is not directly subject to the action of the govern-
ment. The production of gold is free and responds only to the
opportunity for profit. All gold not introduced into trade for con-
sumption or for some other purpose flows into the economy as
money, either as coins in circulation or as bars or coins in bank
reserves. Should the increase in the quantity of money exceed the
increase in the demand for money, then the purchasing power of
the monetary unit must fall. Likewise, if the increase in the quan-
tity of money lags behind the increase in the demand for money,
the purchasing power of the monetary unit will rise.

There is no doubt about the fact that, in the last generation,

the purchasing power of gold has declined. Yet earlier, during the
two decades following the German monetary reform and the
great economic crisis of 1873, there was widespread complaint
over the decline of commodity prices. Governments consulted
experts for advice on how to eliminate this generally prevailing
“evil.” Powerful political parties recommended measures for
pushing prices up by increasing the quantity of money. In place

60 — The Causes of the Economic Crisis

[This is not the place to examine further the theory of the formation of

the purchasing power of the monetary unit. In this connection, see The
Theory of Money and Credit; 1953, pp. 97–165; 1980, pp. 117–85.—Ed.]

of the gold standard, they advocated the silver standard, the dou-
ble standard [bimetallism] or even a paper standard, for they
considered the annual production of gold too small to meet the
growing demand for money without increasing the purchasing
power of the monetary unit. However, these complaints died out
in the last five years of the nineteenth century, and soon men
everywhere began to grumble about the opposite situation, i.e.,
the increasing cost of living. Just as they had proposed monetary
reforms in the 1880s and 1890s to counteract the drop in prices,
they now suggested measures to stop prices from rising.

The general advance of the prices of all goods and services in

terms of gold is due to the state of gold production and the
demand for gold, both for use as money as well as for other pur-
poses. There is little to say about the production of gold and its
influence on the ratio of the value of gold to that of other com-
modities. It is obvious that a smaller increase in the available
quantity of gold might have counteracted the depreciation of
gold. Nor need anything special be said about the industrial uses
of gold. But the third factor involved, the way demand is created
for gold as money, is quite another matter. Very careful attention
should be devoted to this problem, especially as the customary
analysis ignores most unfairly this monetary demand for gold.

During the period for which we are considering the develop-

ment of the purchasing power of gold, various parts of the world,
which formerly used silver or credit money (“paper money”)
domestically, have changed over to the gold standard.
Everywhere, the volume of money transactions has increased
considerably. The division of labor has made great progress.
Economic self-sufficiency and barter have declined. Monetary
exchanges now play a role in phases of economic life where ear-
lier they were completely unknown. The result has been a
decided increase in the demand for money. There is no point in
asking whether this increase in the demand for cash holdings by
individuals, together with the demand for gold for nonmonetary
uses, was sufficient to counteract the effect on prices of the new
gold flowing into the market from production. Statistics on the
height and fluctuations of cash holdings are not available. Even if

Monetary Stabilization and Cyclical Policy — 61

they could be known, they would tell us little because the changes
in prices do not correspond with changes in the relationship
between supply and demand for cash holdings. Of greater impor-
tance, however, is the observation that the increase in the
demand for money is not the same thing as an increase in the
demand for gold for monetary purposes.

As far as the individual’s cash holding is concerned, claims

payable in money, which may be redeemed at any time and are
universally considered safe, perform the service of money. These
money substitutes—small coins, banknotes and bank deposits
subject to check or similar payment on demand (checking
accounts)—may be used just like money itself for the settlement
of all transactions. Only a part of these money substitutes, how-
ever, is fully covered by stocks of gold on deposit in the banks’
reserves. In the decades of which we speak, the use of money
substitutes has increased considerably more than has the rise in
the demand for money and, at the same time, its reserve ratio has
worsened. As a result, in spite of an appreciable increase in the
demand for money, the demand for gold has not risen enough for
the market to absorb the new quantities of gold flowing from
production without lowering its purchasing power.

2. E

CONOMIZING ON

ONEY

If one complains of the decline in the purchasing power of

gold today, and contemplates the creation of a monetary unit
whose purchasing power shall be more constant than that of gold
in recent decades, it should not be forgotten that the principal
cause of the decline in the value of gold during this period is to
be found in monetary policy and not in gold production itself.
Money substitutes not covered by gold, which we call fiduciary
media, occupy a relatively more important position today in the
world’s total quantity of money

than in earlier years. But this is

not a development which would have taken place without the

62 — The Causes of the Economic Crisis

The quantity of “money in the broader sense” is equal to the quantity of

money proper [i.e., commodity money] plus the quantity of fiduciary media
[i.e., notes, bank deposits not backed by metal, and subsidiary coins].

cooperation, or even without the express support, of governmen-
tal monetary policies. As a matter of fact, it was monetary policy
itself which was deliberately aimed at a “saving” of gold and,
which created, thereby, the conditions that led inevitably to the
depreciation of gold.

The fact that we use as money a commodity like gold, which

is produced only with a considerable expenditure of capital and
labor, saddles mankind with certain costs. If the amount of cap-
ital and labor spent for the production of monetary gold could
be released and used in other ways, people could be better sup-
plied with goods for their immediate needs. There is no doubt
about that! However, it should be noted that, in return for this
expenditure, we receive the advantage of having available, for
settling transactions, a money with a relatively steady value and,
what is more important, the value of which is not directly influ-
enced by governments and political parties. However, it is easy
to understand why men began to ponder the possibility of creat-
ing a monetary system that would combine all the advantages
offered by the gold standard with the added virtue of lower
costs.

Adam Smith drew a parallel between the gold and silver which

circulated in a land as money and a highway on which nothing
grew, but over which fodder and grain were brought to market.
The substitution of notes for the precious metals would create, so
to speak, a “wagon-way through the air,” making it possible to
convert a large part of the roads into fields and pastures and,
thus, to increase considerably the yearly output of the economy.
Then in 1816, Ricardo devised his famous plan for a gold
exchange standard. According to his proposal, England should
retain the gold standard, which had proved its value in every
respect. However, gold coins should be replaced in domestic
trade by banknotes, and these notes should be redeemable, not in
gold coins, but in bullion only. Thus the notes would be assured
of a value equivalent to that of gold and the country would have
the advantage of possessing a monetary standard with all the
attributes of the gold standard but at a lower cost.

Monetary Stabilization and Cyclical Policy — 63

Ricardo’s proposals were not put into effect for decades. As a

matter of fact, they were even forgotten. Nevertheless, the gold
exchange standard was adopted by a number of countries during
the 1890s—in the beginning usually as a temporary expedient only,
without intending to direct monetary policy on to a new course.
Today it is so widespread that we would be fully justified in
describing it as “the monetary standard of our age.”

However, in a

majority, or at least in quite a number of these countries, the gold
exchange standard has undergone a development which entitles it
to be spoken of rather as a flexible gold exchange standard.

Under Ricardo’s plan, savings would be realized not only by avoid-
ing the costs of coinage and the loss from wearing coins thin in use,
but also because the amount of gold required for circulation and
bank reserves would be less than under the “pure” gold standard.

Carrying out this plan in a single country must obviously,

ceteris paribus, reduce the purchasing power of gold. And the
more widely the system is adopted, the more must the purchas-
ing power of gold decline. If a single land adopts the gold
exchange standard, while others maintain a “pure” gold standard,
then the gold exchange standard country can gain an immediate
advantage over costs in the other areas. The gold, which is sur-
plus under the gold exchange standard as compared with the gold
which would have been called for under the “pure” gold standard,
may be spent abroad for other commodities. These additional
commodities represent an improvement in the country’s welfare
as a result of introducing the gold exchange standard. The gold
exchange standard renders all the services of the gold standard to

64 — The Causes of the Economic Crisis

Fritz Machlup, Die Goldkernwährung (Halberstadt, 1925), p. xi.

[A monetary standard based on a unit with a flexible gold parity;

Golddevisenkernwährung, literally a standard based on convertibility into a
foreign monetary unit, in effect a “flexible gold exchange standard.” In later
writings, Professor Mises shortened this to “flexible standard” and this
term will be used henceforth in this translation. See Human Action (1949;
3rd rev. ed. (New Haven, Conn.: Yale University Press, 1966); Scholar’s
Edition (Auburn, Ala.: Ludwig von Mises Institute, 1998), chapter XXXI,
section 3.—Ed.]

this country and also brings an additional advantage in the form
of this increase of goods.

However, should every country in the world shift at the same

time from the “pure” gold standard to a similar gold exchange
standard, no gain of this kind would be possible. The distribution
of gold throughout the world would remain unchanged. There
would be no country where one could exchange a quantity of
gold, made superfluous by the adoption of the new monetary sys-
tem, for other goods. Embracing the new standard would result
only in a universally more severe reduction in the purchasing
power of gold. This monetary depreciation, like every change in
the value of money, would bring about dislocations in the rela-
tionships of wealth and income of the various individuals in the
economy. As a result, it could also lead indirectly, under certain
circumstances, to an increase in capital accumulation. However,
this indirect method will make the world richer only insofar as
(1) the demand for gold for other uses (industrial and similar pur-
poses) can be better satisfied and (2) a decline in profitability
leads to a restriction of gold production and so releases capital
and labor for other purposes.

3. I

NTEREST ON

“I

DLE

” R

ESERVES

In addition to these attempts toward “economy” in the oper-

ation of the gold standard, by reducing the domestic demand for
gold, other efforts have also aimed at the same objective.
Holding gold reserves is costly to the banks of issue because of
the loss of interest. Consequently, it was but a short step to the
reduction of these costs by permitting noninterest-bearing gold
reserves in bank vaults to be replaced by interest-bearing credit
balances abroad, payable in gold on demand, and by bills of
exchange payable in gold. Assets of this type enable the banks of
issue to satisfy demands for gold in foreign trade just as the pos-
session of a stock of gold coins and bars would. As a matter of
fact, the dealer in arbitrage who presents notes for redemption
will prefer payment in the form of checks, and bills of
exchange—foreign financial paper—to redemption in gold
because the costs of shipping foreign financial papers are lower

Monetary Stabilization and Cyclical Policy — 65

than those for the transport of gold. The banks of smaller and
poorer lands especially converted a part of their reserves into
foreign bills of exchange. The inducement was particularly
strong in countries on the gold exchange standard, where the
banks did not have to consider a demand for gold for use in
domestic circulation. In this way, the gold exchange standard
[Goldkernwährung] became the flexible gold exchange standard
[Golddevisenkernwährung], i.e., the flexible standard.

Nevertheless, the goal of this policy was not only to reduce the

costs involved in the maintenance and circulation of an actual
stock of gold. In many countries, including Germany and Austria,
this was thought to be a way to reduce the rate of interest. The
influence of the Currency Theory had led, decades earlier, to
banking legislation intended to avoid the consequences of a
paper money inflation. These laws, limiting the issue of bank-
notes not covered by gold, were still in force. Reared in the
Historical-Realistic School of economic thinking, the new gener-
ation, insofar as it dealt with these problems, was under the spell
of the Banking Theory, and thus no longer understood the mean-
ing of these laws.

Lack of originality prevented the new generation from

embarking upon any startling reversal in policy. In line with cur-
rently prevailing opinion, it abolished the limitation on the issue
of banknotes not covered by metal. The old laws were allowed to
stay on the books essentially unchanged. However, various
attempts were made to reduce their effect. The most noteworthy
of these measures was to encourage, systematically and purpose-
fully, the settlement of transactions without the use of cash. By
supplanting cash transactions with checks and other transfer
payments, it was expected not only that there would be a reduc-
tion in the demand for banknotes but also a flow of gold coins
back to the bank and, consequently, a strengthening of the bank’s
cash position. As German, and also Austrian, banking legislation
prescribed a certain percentage of gold cover for notes issued,
gold flowing back to the bank meant that more notes could be
issued—up to three times their gold value in Germany and two
and a half times in Austria. During recent decades, the banking

66 — The Causes of the Economic Crisis

theory has been characterized by a belief that this should result
in a reduction in the rate of interest.

4. G

OLD

TILL

ONEY

If we glance, even briefly, at the efforts of monetary and bank-

ing policy in recent years, it becomes obvious that the
depreciation of gold may be traced in large part to political meas-
ures. The decline in the purchasing power of gold and the
continual increase in the gold price of all goods and services were
not natural phenomena. They were consequences of an eco-
nomic policy which aimed, to be sure, at other objectives, but
which necessarily led to these results. As has already been men-
tioned, accurate quantitative observations about these matters
can never be made. Nevertheless, it is obvious that the increase
in gold production has certainly not been the cause, or at least
not the only cause, of the depreciation of gold that has been
observed since 1896. The policy directed toward displacing gold
in actual circulation, which aimed at substituting the gold
exchange standard and the flexible standard for the older “pure”
gold standard, forced the value of gold down or at least helped to
depress it. Perhaps, if this policy had not been followed, we would
hear complaints today over the increase, rather than the depreci-
ation, in the value of gold.

Gold has not been demonetized by the new monetary policy,

as silver was a short time ago, for it remains the basis of our
entire monetary system. Gold is still, as it was formerly, our
money. There is no basis for saying that it has been de-throned,
as suggested by scatterbrained innovators of catchwords and
slogans who want to cure the world of the “money illusion.”
Nevertheless, gold has been removed from actual use in transac-
tions by the public at large. It has disappeared from view and has
been concentrated in bank vaults and monetary reserves. Gold
has been taken out of common use and this must necessarily
tend to lower its value.

It is wrong to point to the general price increases of recent

years to illustrate the inadequacy of the gold standard. It is not
the old style gold standard, as recommended by advocates of the

Monetary Stabilization and Cyclical Policy — 67

gold standard in England and Germany, which has given us a
monetary system that has led to rising prices in recent years.
Rather these price increases have been the results of monetary
and banking policies which permitted the “pure” or “classical”
gold standard to be replaced by the gold exchange and flexible
standards, leaving in circulation only notes and small coins and
concentrating the gold stocks in bank and currency reserves.

III.

“M

ANIPULATION OF THE

OLD

TANDARD

”

1. M

ONETARY

OLICY AND

URCHASING

OWER OF

OLD

Most important for the old, “pure,” or classical gold standard,

as originally formulated in England and later, after the formation
of the Empire, adopted in Germany, was the fact that it made the
formation of prices independent of political influence and the
shifting views which sway political action. This feature especially
recommended the gold standard to liberals

who feared that eco-

nomic productivity might be impaired as a result of the tendency
of governments to favor certain groups of persons at the expense
of others.

68 — The Causes of the Economic Crisis

I employ the term “liberal” in the sense attached to it everywhere
in the nineteenth century and still today in the countries of conti-
nental Europe. This usage is imperative because there is simply no
other term available to signify the political and intellectual move-
ment that substituted free enterprise and the market economy for
the precapitalistic methods of production; constitutional repre-
sentative government from the absolutism of kings or oligarchies;
and freedom of all individuals from slavery, serfdom, and other
forms of bondage. (“Foreword to the Third Edition,” Human
Action [New Haven, Conn.: Yale University Press, 1963], p. v)

However, it should certainly not be forgotten that under the

“pure” gold standard governmental measures may also have a sig-
nificant influence on the formation of the value of gold. In the
first place, governmental actions determine whether to adopt the
gold standard, abandon it, or return to it. However, the effect of
these governmental actions, which we need not consider any fur-
ther here, is conceived as very different from those described by
the various “state theories of money”—theories which, now at
long last, are generally recognized as absurd. The continual dis-
placement of the silver standard by the gold standard and the
shift in some countries from credit money to gold added to the
demand for monetary gold in the years before the World War
[1914–1918]. War measures resulted in monetary policies that
led the belligerent nations, as well as some neutral states, to
release large parts of their gold reserves, thus releasing more gold
for world markets. Every political act in this area, insofar as it
affects the demand for, and the quantity of, gold as money, repre-
sents a “manipulation” of the gold standard and affects all
countries adhering to the gold standard.

Just as the “pure” gold, the gold exchange and the flexible stan-

dards do not differ in principle, but only in the degree to which
money substitutes are actually used in circulation, so is there no
basic difference in their susceptibility to manipulation. The
“pure” gold standard is subject to the influence of monetary
measures—on the one hand, insofar as monetary policy may
affect the acceptance or rejection of the gold standard in a polit-
ical area and, on the other hand, insofar as monetary policy, while
still clinging to the gold standard in principle, may bring about
changes in the demand for gold through an increase or decrease
in actual gold circulation or by changes in reserve requirements
for banknotes and checking accounts. The influence of monetary
policy on the formation of the value [i.e., the purchasing power]
of gold also extends just that far and no farther under the gold
exchange and flexible standards. Here again, governments and
those agencies responsible for monetary policy can influence the
formation of the value of gold by changing the course of mone-
tary policy. The extent of this influence depends on how large the

Monetary Stabilization and Cyclical Policy — 69

increase or decrease in the demand for gold is nationally, in rela-
tion to the total world demand for gold.

If advocates of the old “pure” gold standard spoke of the inde-

pendence of the value of gold from governmental influences, they
meant that once the gold standard had been adopted everywhere
(and gold standard advocates of the last three decades of the nine-
teenth century had not the slightest doubt that this would soon
come to pass, for the gold standard had already been almost uni-
versally accepted) no further political action would affect the
formation of monetary value. This would be equally true for both
the gold exchange and flexible standards. It would by no means
disturb the logical assumptions of the perceptive “pure” gold stan-
dard advocate to say that the value of gold would be considerably
affected by a change in United States Federal Reserve Board pol-
icy, such as the resumption of the circulation of gold or the
retention of larger gold reserves in European countries. In this
sense, all monetary standards may be “manipulated” under today’s
economic conditions. The advantage of the gold standard—
whether “pure” or “gold exchange”—is due solely to the fact that,
if once generally adopted in a definite form, and adhered to, it is
no longer subject to specific political interferences.

War and postwar actions, with respect to monetary policy,

have radically changed the monetary situation throughout the
entire world. One by one, individual countries are now [1928]
reverting to a gold basis and it is likely that this process will
soon be completed. Now, this leads to a second problem: Should
the exchange standard, which generally prevails today, be
retained? Or should a return be made once more to the actual
use of gold in moderate-sized transactions as before under the
“pure” gold standard? Also, if it is decided to remain on the
exchange standard, should reserves actually be maintained in
gold? And at what height? Or could individual countries be sat-
isfied with reserves of foreign exchange payable in gold?
(Obviously, the flexible standard cannot become entirely univer-
sal. At least one country must continue to invest its reserves in
real gold, even if it does not use gold in actual circulation.) Only
if the state of affairs prevailing at a given instant in every single

70 — The Causes of the Economic Crisis

area is maintained and, also, only if matters are left just as they
are, including of course the ratio of bank reserves, can it be said
that the gold standard cannot be manipulated in the manner
described above. If these problems are dealt with in such a way
as to change markedly the demand for gold for monetary pur-
poses, then the purchasing power of gold must undergo
corresponding changes.

To repeat for the sake of clarity, this represents no essential

disagreement with the advocates of the gold standard as to what
they considered its special superiority. Changes in the monetary
system of any large and wealthy land will necessarily influence
substantially the creation of monetary value. Once these changes
have been carried out and have worked their effect on the pur-
chasing power of gold, the value of money will necessarily be
affected again by a return to the previous monetary system.
However, this detracts in no way from the truth of the statement
that the creation of value under the gold standard is independent
of politics, so long as no essential changes are made in its struc-
ture, nor in the size of the area where it prevails.

2. C

HANGES IN

URCHASING

OWER OF

OLD

Irving Fisher, as well as many others, criticize the gold stan-

dard because the purchasing power of gold has declined
considerably since 1896, and especially since 1914. In order to
avoid misunderstanding, it should be pointed out that this drop
in the purchasing power of gold must be traced back to monetary
policy—monetary policy which fostered the reduction in the
purchasing power of gold through measures adopted between
1896 and 1914, to “economize” gold and, since 1914, through the
rejection of gold as the basis for money in many countries. If oth-
ers denounce the gold standard because the imminent return to
the actual use of gold in circulation and the strengthening of gold
reserves in countries on the exchange standard would bring
about an increase in the purchasing power of gold, then it
becomes obvious that we are dealing with the consequences of
political changes in monetary policy which transform the struc-
ture of the gold standard.

Monetary Stabilization and Cyclical Policy — 71

The purchasing power of gold is not “stable.” It should be

pointed out that there is no such thing as “stable” purchasing
power, and never can be. The concept of “stable value” is vague
and indistinct. Strictly speaking, only an economy in the final
state of rest—where all prices remain unchanged—could have a
money with fixed purchasing power. However, it is a fact which
no one can dispute that the gold standard, once generally
adopted and adhered to without changes, makes the formation of
the purchasing power of gold independent of the operations of
shifting political efforts.

As gold is obtained only from a few sources, which sooner or

later will be exhausted, the fear is repeatedly expressed that there
may someday be a scarcity of gold and, as a consequence, a con-
tinuing decline in commodity prices. Such fears became
especially great in the late 1870s and the 1880s. Then they qui-
eted down. Only in recent years have they been revived again.
Calculations are made indicating that the placers and mines cur-
rently being worked will be exhausted within the foreseeable
future. No prospects are seen that any new rich sources of gold
will be opened up. Should the demand for money increase in the
future, to the same extent as it has in the recent past, then a gen-
eral price drop appears inevitable, if we remain on the gold
standard.

Now one must be very cautious with forecasts of this kind. A

half century ago, Eduard Suess, the geologist, claimed—and he
sought to establish this scientifically—that an unavoidable
decline in gold production should be expected.

Facts very soon

proved him wrong. And it may be that those who express similar
ideas today will also be refuted just as quickly and just as thor-
oughly. Still we must agree that they are right in the final analysis,
that prices are tending to fall [1928] and that all the social conse-
quences of an increase in purchasing power are making their

72 — The Causes of the Economic Crisis

Gustav Cassell, Währungsstabilisierung als Weltproblem (Leipzig,

1928), p. 12.

[Eduard Suess (1831–1914) published a study in German (1877) on

“The Future of Gold.”— Ed.]

appearance. What may be ventured, given the circumstances, in
order to change the economic pessimism, will be discussed at the
end of the second part of this study.

IV.

“M

EASURING

” C

HANGES IN THE

URCHASING

OWER OF THE

ONETARY

NIT

1. I

MAGINARY

ONSTRUCTIONS

All proposals to replace the commodity money, gold, with a

money thought to be better, because it is more “stable” in value,
are based on the vague idea that changes in purchasing power
can somehow be measured. Only by starting from such an
assumption is it possible to conceive of a monetary unit with
unchanging purchasing power as the ideal and to consider seek-
ing ways to reach this goal. These proposals, vague and basically
contradictory, are derived from the old, long since exploded,
objective theory of value. Yet they are not even completely con-
sistent with that theory. They now appear very much out of place
in the company of modern, subjective economics.

The prestige which they still enjoy can be explained only by

the fact that, until very recently, studies in subjective economics
have been restricted to the theory of direct exchange (barter).
Only lately have such studies been expanded to include also the
theory of intermediate (indirect) exchange, i.e., the theory of a
generally accepted medium of exchange (monetary theory) and
the theory of fiduciary media (banking theory) with all their rel-
evant problems.

It is certainly high time to expose conclusively

the errors and defects of the basic concept that purchasing power
can be measured.

Monetary Stabilization and Cyclical Policy — 73

[The Theory of Money and Credit, 1953, pp. 116ff.; 1980, pp. 138ff.—

Ed.]

Exchange ratios on the market are constantly subject

to change. If we imagine a market where no generally accepted
medium of exchange, i.e., no money, is used, it is easy to recog-
nize how nonsensical the idea is of trying to measure the
changes taking place in exchange ratios. It is only if we resort to
the fiction of completely stationary exchange ratios among all
commodities, other than money, and then compare these other
commodities with money, that we can envisage exchange rela-
tionships between money and each of the other individual
exchange commodities changing uniformly. Only then can we
speak of a uniform increase or decrease in the monetary price of
all commodities and of a uniform rise or fall of the “price level.”
Still, we must not forget that this concept is pure fiction, what
Vaihinger termed an “as if.”

It is a deliberate imaginary con-

struction, indispensable for scientific thinking.

Perhaps the necessity for this imaginary construction will

become somewhat more clear if we express it, not in terms of the
objective exchange value of the market, but in terms of the sub-
jective exchange valuation of the acting individual. To do that, we
must imagine an unchanging man with never-changing values.
Such an individual could determine, from his never-changing
scale of values, the purchasing power of money. He could say pre-
cisely how the quantity of money, which he must spend to attain
a certain amount of satisfaction, had changed. Nevertheless, the
idea of a definite structure of prices, a “price level,” which is raised
or lowered uniformly, is just as fictitious as this. However, it
enables us to recognize clearly that every change in the exchange
ratio between a commodity, on the one side, and money, on the
other, must necessarily lead to shifts in the disposition of wealth
and income among acting individuals. Thus, each such change
acts as a dynamic agent also. In view of this situation, therefore,
it is not permissible to make such an assumption as a uniformly
changing “level” of prices.

74 — The Causes of the Economic Crisis

Hans Vaihinger (1852–1933), author of The Philosophy of As If

(German, 1911; English translation, 1924).

This imaginary construction is necessary, however, to explain

that the exchange ratios of the various economic goods may
undergo a change from the side of one individual commodity.
This fictional concept is the ceteris paribus of the theory of
exchange relationships. It is just as fictitious and, at the same
time, just as indispensable as any ceteris paribus. If extraordinary
circumstances lead to exceptionally large and hence conspicuous
changes in exchange ratios, data on market phenomena may help
to facilitate sound thinking on these problems. However, then
even more than ever, if we want to see the situation at all clearly,
we must resort to the imaginary construction necessary for an
understanding of our theory.

The expressions, “inflation” and “deflation,” scarcely known in

German economic literature several years ago, are in daily use
today. In spite of their inexactness, they are undoubtedly suit-
able for general use in public discussions of economic and
political problems.

But in order to understand them precisely,

one must elaborate with rigid logic that fictional concept [the
imaginary construction of completely stationary exchange ratios
among all commodities other than money], the falsity of which
is clearly recognized.

Among the significant services performed by this fiction is

that it enables us to distinguish and determine whether changes
in exchange relationships between money and other commodi-
ties arise on the money side or the commodity side. In order to
understand the changes which take place constantly on the mar-
ket, this distinction is urgently needed. It is still more
indispensable for judging the significance of measures proposed
or adopted in the field of monetary and banking policy. Even in
these cases, however, we can never succeed in constructing a fic-
tional representation that coincides with the situation which
actually appears on the market. The imaginary construction

Monetary Stabilization and Cyclical Policy — 75

[The Theory of Money and Credit, 1953, pp. 239ff; 1980, pp. 271ff.—

Ed.]

makes it easier to understand reality, but we must remain con-
scious of the distinction between fiction and reality.

76 — The Causes of the Economic Crisis

[At this point, in a footnote, Professor Mises commented on a contro-

versy he had had with a student over terminology. He again recommended,
as he had in 1923 (see above, p. 1, n. 1), continuing to use Menger’s terms
which enjoyed general acceptance. The simpler English terms, which Mises
developed and adopted later—notably in Human Action (3rd rev. ed., 1966,
pp. 419–24; 1998, pp. 416–21), where he describes “goods-induced” or
“cash-induced” changes in the value of the monetary unit—are used in this
translation. For those who may be interested in this controversy, the origi-
nal footnote follows:

Carl Menger referred to the nature and extent of the influence exerted on

money/goods exchange ratios [prices] by changes from the money side as
the problem of the “internal” exchange value (innere Tauschwert) of money
[translated in this volume as “cash-induced changes”]. He referred to the
variations in the purchasing power of the monetary unit due to other
causes as changes in the “external” exchange value (aussere Tauschwert) of
money [translated as “goods-induced changes”]. I have criticized both
expressions as being rather unfortunate—because of possible confusion
with the terms “extrinsic and intrinsic value” as used in Roman canon doc-
trine, and by English authors of the seventeenth and eighteenth centuries.
(See the German editions of my book on The Theory of Money and Credit,
1912, p. 132; 1924, p. 104). Nevertheless, this terminology has attained sci-
entific acceptance through its use by Menger and it will be used in this
study when appropriate.

There is no need to discuss an expression which describes a useful and

indispensable idea. It is the concept itself, not the term used to describe it,
which is important. Serious mischief is done if an author chooses a new
term unnecessarily to express a concept for which a name already exists.
My student, Gottfried Haberler, has criticized me severely for taking this
position, reproaching me for being a slave to semantics. (See Haberler, Der
Sinn der Indexzahlen [Tübingen, 1927], pp. 109ff.). However, in his relevant
remarks on this problem, Haberler says nothing more than I have. He too
distinguishes between price changes arising on the goods and money sides.
Beginners should seek to expand knowledge and avoid spending time on
useless terminological disputes. As Haberler points out, it would obviously
be wasted effort to “seek internal and external exchange values of money in
the real world.” Ideas do not belong to the “real world” at all, but to the
world of thought and knowledge.

It is even more astonishing that Haberler finds my critique of attempts to

measure the value of the monetary unit “inexpedient,” especially as his
analysis rests entirely on mine.—Ed.]

2. I

NDEX

UMBERS

Attempts have been made to measure changes in the purchas-

ing power of money by using data derived from changes in the
money prices of individual economic goods. These attempts rest
on the theory that, in a carefully selected index of a large number,
or of all consumers’ goods, influences from the commodity side
affecting commodity prices cancel each other out. Thus, so the
theory goes, the direction and extent of the influence on prices of
factors arising on the money side may be discovered from such
an index. Essentially, therefore, by computing an arithmetical
mean, this method seeks to convert the price changes emerging
among the various consumers’ goods into a figure which may
then be considered an index to the change in the value of money.
In this discussion, we shall disregard the practical difficulties
which arise in assembling the price quotations necessary to serve
as the basis for such calculations and restrict ourselves to com-
menting on the fundamental usefulness of this method for the
solution of our problem.

First of all it should be noted that there are various arithmeti-

cal means. Which one should be selected? That is an old
question. Reasons may be advanced for, and objections raised
against, each. From our point of view, the only important thing to
be learned in such a debate is that the question cannot be settled
conclusively so that everyone will accept any single answer as
“right.”

The other fundamental question concerns the relative

importance of the various consumer goods. In developing the
index, if the price of each and every commodity is considered as
having the same weight, a 50 percent increase in the price of
bread, for instance, would be offset in calculating the arithmeti-
cal average by a drop of one-half in the price of diamonds. The
index would then indicate no change in purchasing power, or
“price level.” As such a conclusion is obviously preposterous,
attempts are made in fabricating index numbers, to use the
prices of various commodities according to their relative impor-
tance. Prices should be included in the calculations according to

Monetary Stabilization and Cyclical Policy — 77

the coefficient of their importance. The result is then known as
a “weighted” average.

This brings us to the second arbitrary decision necessary for

developing such an index. What is “importance”? Several differ-
ent approaches have been tried and arguments pro and con each
have been raised. Obviously, a clear-cut, all-round satisfactory
solution to the problem cannot be found. Special attention has
been given the difficulty arising from the fact that, if the usual
method is followed, the very circumstances involved in deter-
mining “importance” are constantly in flux; thus the coefficient
of importance itself is also continuously changing.

As soon as one starts to take into consideration the “importance”

of the various goods, one forsakes the assumption of objective
exchange value—which often leads to nonsensical conclusions as
pointed out above—and enters the area of subjective values. Since
there is no generally recognized immutable “importance” to various
goods, since “subjective” value has meaning only from the point of
view of the acting individual, further reflection leads eventually to
the subjective method already discussed—namely the inexcusable
fiction of a never-changing man with never-changing values. To
avoid arriving at this conclusion, which is also obviously absurd,
one remains indecisively on the fence, midway between two equally
nonsensical methods—on the one side the un-weighted average
and on the other the fiction of a never-changing individual with
never-changing values. Yet one believes he has discovered some-
thing useful. Truth is not the halfway point between two untruths.
The fact that each of these two methods, if followed to its logical
conclusion, is shown to be preposterous, in no way proves that a
combination of the two is the correct one.

All index computations pass quickly over these unanswerable

objections. The calculations are made with whatever coefficients
of importance are selected. However, we have established that
even the problem of determining “importance” is not capable of
solution, with certainty, in such a way as to be recognized by
everyone as “right.”

Thus the idea that changes in the purchasing power of money

may be measured is scientifically untenable. This will come as no

78 — The Causes of the Economic Crisis

surprise to anyone who is acquainted with the fundamental prob-
lems of modern subjectivistic catallactics and has recognized the
significance of recent studies with respect to the measurement of
value

and the meaning of monetary calculation.

One can certainly try to devise index numbers. Nowadays

nothing is more popular among statisticians than this.
Nevertheless, all these computations rest on a shaky foundation.
Disregarding entirely the difficulties which, from time to time,
even thwart agreement as to the commodities whose prices will
form the basis of these calculations, these computations are arbi-
trary in two ways—first, with respect to the arithmetical mean
chosen and, secondly, with respect to the coefficient of impor-
tance selected. There is no way to characterize one of the many
possible methods as the only “correct” one and the others as
“false.” Each is equally legitimate or illegitimate. None is scientif-
ically meaningful.

It is small consolation to point out that the results of the vari-

ous methods do not differ substantially from one another. Even if
that is the case, it cannot in the least affect the conclusions we
must draw from the observations we have made. The fact that
people can conceive of such a scheme at all, that they are not
more critical, may be explained only by the eventuality of the
great inflations, especially the greatest and most recent one.

Any index method is good enough to make a rough statement

about the extremely severe depreciation of the value of a mone-
tary unit, such as that wrought in the German inflation. There,
the index served an instructional task, enlightening a people who
were inclined to the “State Theory of Money” idea. Nevertheless,
a method that helps to open the eyes of the people is not neces-
sarily either scientifically correct or applicable in actual practice.

Monetary Stabilization and Cyclical Policy — 79

[See The Theory of Money and Credit, 1953, pp. 38ff.; 1980, pp. 51ff.—

Ed.]

[See Socialism (New Haven, Conn.: Yale University Press, 1951), pp.

121ff. and (Indianapolis, Ind.: Liberty Fund, 1981), pp. 104.—Ed.]

ISHER

’

TABILIZATION

LAN

1. P

OLITICAL

ROBLEM

The superiority of the gold standard consists in the fact that

the value of gold develops independent of political actions. It is
clear that its value is not “stable.” There is not, and never can be,
any such thing as stability of value. If, under a “manipulated”
monetary standard, it was government’s task to influence the
value of money, the question of how this influence was to be exer-
cised would soon become the main issue among political and
economic interests. Government would be asked to influence the
purchasing power of money so that certain politically powerful
groups would be favored by its intervention, at the expense of the
rest of the population. Intense political battles would rage over
the direction and scope of the edicts affecting monetary policy.
At times, steps would be taken in one direction, and at other
times in other directions—in response to the momentary balance
of political power. The steady, progressive development of the
economy would continually experience disturbances from the
side of money. The result of the manipulation would be to pro-
vide us with a monetary system which would certainly not be any
more stable than the gold standard.

If the decision were made to alter the purchasing power of

money so that the index number always remained unchanged, the
situation would not be any different. We have seen that there are
many possible ways, not just one single way, to determine the index
number. No single one of these methods can be considered the only
correct one. Moreover, each leads to a different conclusion. Each
political party would advocate the index method which promised
results consistent with its political aims at the time. Since it is not
scientifically possible to find one of the many methods objectively
right and to reject all others as false, no judge could decide impar-
tially among groups disputing the correct method of calculation.

80 — The Causes of the Economic Crisis

In addition, however, there is still one more very important

consideration. The early proponents of the Quantity Theory
believed that changes in the purchasing power of the monetary
unit caused by a change in the quantity of money were exactly
inversely proportional to one another. According to this Theory,
a doubling of the quantity of money would cut the monetary
unit’s purchasing power in half. It is to the credit of the more
recently developed monetary theory that this version of the
Quantity Theory has been proved untenable. An increase in the
quantity of money must, to be sure, lead ceteris paribus to a
decline in the purchasing power of the monetary unit. Still the
extent of this decrease in no way corresponds to the extent of the
increase in the quantity of money. No fixed quantitative relation-
ship can be established between the changes in the quantity of
money and those of the unit’s purchasing power.

Hence, every

manipulation of the monetary standard will lead to serious diffi-
culties. Political controversies would arise not only over the
“need” for a measure, but also over the degree of inflation or
restriction, even after agreement had been reached on the pur-
pose the measure was supposed to serve.

All this is sufficient to explain why proposals for establishing a

manipulated standard have not been popular. It also explains—
even if one disregards the way finance ministers have abused
their authority—why credit money (commonly known as “paper
money”) is considered “bad” money. Credit money is considered
“bad money” precisely because it may be manipulated.

2. M

ULTIPLE

OMMODITY

TANDARD

Proposals that a multiple commodity standard replace, or sup-

plement, monetary standards based on the precious metals—in
their role as standards of deferred payments—are by no means
intended to create a manipulated money. They are not intended
to change the precious metals standard itself nor its effect on
value. They seek merely to provide a way to free all transactions

Monetary Stabilization and Cyclical Policy — 81

[See The Theory of Money and Credit, 1953, pp. 139ff.; 1980, pp.

161ff.—Ed.]

involving future monetary payments from the effect of changes
in the value of the monetary unit. It is easy to understand why
these proposals were not put into practice. Relying as they do on
the shaky foundation of index number calculations, which can-
not be scientifically established, they would not have produced a
stable standard of value for deferred payments. They would only
have created a different standard with different changes in value
from those under the gold metallic standard.

To some extent Fisher’s proposals parallel the early ideas of

advocates of a multiple commodity standard. These forerunners
also tried to eliminate only the influence of the social effects of
changes in monetary value on the content of future monetary
obligations. Like most Anglo-American students of this problem,
as well as earlier advocates of a multiple commodity standard,
Fisher took little notice of the fact that changes in the value of
money have other social effects also.

Fisher, too, based his proposals entirely on index numbers.

What seems to recommend his scheme, as compared with pro-
posals for introducing a “multiple standard,” is the fact that he
does not use index numbers directly to determine changes in
purchasing power over a long period of time. Rather he uses
them primarily to understand changes taking place from month
to month only. Many objections raised against the use of the
index method for analyzing longer periods of time will perhaps
appear less justified when considering only shorter periods. But
there is no need to discuss this question here, for Fisher did not
confine the application of his plan to short periods only. Also,
even if adjustments are always made from month to month only,
they were to be carried forward, on and on, until eventually cal-
culations were being made, with the help of the index number,
which extended over long periods of time. Because of the imper-
fection of the index number, these calculations would necessarily
lead in time to errors of very considerable proportions.

3. P

RICE

REMIUM

Fisher’s most important contribution to monetary theory is

the emphasis he gave to the previously little noted effect of

82 — The Causes of the Economic Crisis

changes in the value of money on the formation of the interest
rate.

Insofar as movements in the purchasing power of money

can be foreseen, they find expression in the gross interest rate—
not only as to the direction they will take but also as to their
approximate magnitude. That portion of the gross interest rate
which is demanded, and granted, in view of anticipated changes
in purchasing power is known as the purchasing-power-change
premium or price-change premium. In place of these clumsy
expressions we shall use a shorter term—“price premium.”
Without any further explanation, this terminology leads to an
understanding of the fact that, given an anticipation of general
price increases, the price premium is “positive,” thus raising the
gross rate of interest. On the other hand, with an anticipation of
general price decreases, the price premium becomes “negative”
and so reduces the gross interest rate.

The individual businessman is not generally aware of the fact

that monetary value is affected by changes from the side of
money. Even if he were, the difficulties which hamper the forma-
tion of a halfway reliable judgment, as to the direction and extent
of anticipated changes, are tremendous, if not outright insur-
mountable. Consequently, monetary units used in credit
transactions are generally regarded rather naïvely as being “sta-
ble” in value. So, with agreement as to conditions under which
credit will be applied for and granted, a price premium is not
generally considered in the calculation. This is practically always
true, even for long-term credit. If opinion is shaken as to the “sta-
bility of value” of a certain kind of money, this money is not used
at all in long-term credit transactions. Thus, in all nations using
credit money, whose purchasing power fluctuated violently,
long-term credit obligations were drawn up in gold, whose value
was held to be “stable.”

However, because of obstinacy and pro-government bias,

this course of action was not employed in Germany, nor in
other countries during the recent inflation. Instead, the idea

Monetary Stabilization and Cyclical Policy — 83

Irving Fisher, The Rate of Interest (New York, 1907), pp. 77ff.

was conceived of making loans in terms of rye and potash. If
there had been no hope at all of a later compensating revaluation
of these loans, their price on the exchange in German marks,
Austrian crowns and similarly inflated currencies would have
been so high that a positive price premium corresponding to the
magnitude of the anticipated further depreciation of these cur-
rencies would have been reflected in the actual interest
payment.

The situation is different with respect to short-term credit

transactions. Every businessman estimates the price changes
anticipated in the immediate future and guides himself accord-
ingly in making sales and purchases. If he expects an increase in
prices, he will make purchases and postpone sales. To secure the
means for carrying out this plan, he will be ready to offer higher
interest than otherwise. If he expects a drop in prices, then he
will seek to sell and to refrain from purchasing. He will then be
prepared to lend out, at a cheaper rate, the money made available
as a result. Thus, the expectation of price increases leads to a pos-
itive price premium, that of price declines to a negative price
premium.

To the extent that this process correctly anticipates the price

movements that actually result, with respect to short-term credit,
it cannot very well be maintained that the content of contractual
obligations are transformed by the change in the purchasing
power of money in a way which was neither foreseen nor con-
templated by the parties concerned. Nor can it be maintained
that, as a result, shifts take place in the wealth and income rela-
tionship between creditor and debtor. Consequently, it is
unnecessary, so far as short-term credit is concerned, to look for
a more perfect standard of deferred payments.

Thus we are in a position to see that Fisher’s proposal actu-

ally offers no more than was offered by any previous plan for a
multiple standard. In regard to the role of money as a standard
of deferred payments, the verdict must be that, for long-term
contracts, Fisher’s scheme is inadequate. For short-term commit-
ments, it is both inadequate and superfluous.

84 — The Causes of the Economic Crisis

4. C

HANGES IN

EALTH AND

NCOME

However, the social consequences of changes in the value of

money are not limited to altering the content of future monetary
obligations. In addition to these social effects, which are generally
the only ones dealt with in Anglo-American literature, there are
still others. Changes in money prices never reach all commodities
at the same time, and they do not affect the prices of the various
goods to the same extent. Shifts in relationships between the
demand for, and the quantity of, money for cash holdings gener-
ated by changes in the value of money from the money side do not
appear simultaneously and uniformly throughout the entire econ-
omy. They must necessarily appear on the market at some definite
point, affecting only one group in the economy at first, influencing
only their judgments of value in the beginning and, as a result, only
the prices of commodities these particular persons are demanding.
Only gradually does the change in the purchasing power of the
monetary unit make its way throughout the entire economy.

For example, if the quantity of money increases, the additional

new quantity of money must necessarily flow first of all into the
hands of certain definite individuals—gold producers, for exam-
ple, or, in the case of paper money inflation, the coffers of the
government. It changes only their incomes and fortunes at first
and, consequently, only their value judgments. Not all goods go
up in price in the beginning, but only those goods which are
demanded by these first beneficiaries of the inflation. Only later
are prices of the remaining goods raised, as the increased quan-
tity of money progresses step by step throughout the land and
eventually reaches every participant in the economy.

But even

then, when finally the upheaval of prices due to the new quantity
of money has ended, the prices of all goods and services will not
have increased to the same extent. Precisely because the price
increases have not affected all commodities at one time, shifts in
the relationships in wealth and income are effected which affect

Monetary Stabilization and Cyclical Policy — 85

Hermann Heinrich Gossen, Entwicklung der Gesetze des menschlichen

Verkehrs und der daraus fliessenden Regeln für menschliches Handeln (new
ed.; Berlin, 1889), p. 206.

the supply and demand of individual goods and services differ-
ently. Thus, these shifts must lead to a new orientation of the
market and of market prices.

Suppose we ignore the consequences of changes in the value

of money on future monetary obligations. Suppose further that
changes in the purchasing power of money occur simultaneously
and uniformly with respect to all commodities in the entire econ-
omy. Then, it becomes obvious that changes in the value of
money would produce no changes in the wealth of the individual
entrepreneurs. Changes in the value of the monetary unit would
then have no more significance for them than changes in weights
and measures or in the calendar.

It is only because changes in the purchasing power of money

never affect all commodities everywhere simultaneously that
they bring with them (in addition to their influence on debt
transactions) still other shifts in wealth and income. The groups
which produce and sell the commodities that go up in price first
are benefited by the inflation, for they realize higher profits in the
beginning and yet they can still buy the commodities they need
at lower prices, reflecting the previous stock of money. So during
the inflation of the World War [1914–1918], the producers of war
materiel and the workers in war industries, who received the out-
put of the printing presses earlier than other groups of people,
benefited from the monetary depreciation. At the same time,
those whose incomes remained nominally the same suffered
from the inflation, as they were forced to compete in making pur-
chases with those receiving war inflated incomes. The situation
became especially clear in the case of government employees.
There was no mistaking the fact that they were losers. Salary
increases came to them too late. For some time they had to pay
prices, already affected by the increase in the quantity of money,
with money incomes related to previous conditions.

5. U

NCOMPENSATABLE

HANGES

In the case of foreign trade, it was just as easy to see the conse-

quences of the fact that price changes of the various commodities
did not take place simultaneously. The deterioration in the value

86 — The Causes of the Economic Crisis

of the monetary unit encourages exports because a part of the
raw materials, semi-produced factors of production and labor
needed for the manufacture of export commodities, were pro-
cured at the old lower prices. At the same time the change in
purchasing power, which for the time being has affected only a
part of the domestically-produced commodities, has already had
an influence on the rate of exchange on the Bourse. The result is
that the exporter realizes a specific monetary gain.

The changes in purchasing power arising on the money side

are considered disturbing not merely because of the transforma-
tion they bring about in the content of future monetary
obligations. They are also upsetting because of the uneven timing
of the price changes of the various goods and services. Can
Fisher’s dollar of “stable value” eliminate these price changes?

In order to answer this question, it must be restated that

Fisher’s proposal does not eliminate changes in the value of the
monetary unit. It attempts instead to compensate for these
changes continuously—from month to month. Thus the conse-
quences associated with the step-by-step emergence of changes
in purchasing power are not eliminated. Rather they materialize
during the course of the month. Then, when the correction is
made at the end of the month, the course of monetary deprecia-
tion is still not ended. The adjustment calculated at that time is
based on the index number of the previous month when the full
extent of that month’s monetary depreciation had not then been
felt because all prices had not yet been affected. However, the
prices of goods for which demand was forced up first by the addi-
tional quantity of money undoubtedly reached heights that may
not be maintained later.

Whether or not these two deviations in prices correspond in

such a way that their effects cancel each other out will depend on
the specific data in each individual case. Consequently, the mon-
etary depreciation will continue in the following month, even if
no further increase in the quantity of money were to appear in
that month. It would continue to go on until the process finally
ended with a general increase in commodity prices, in terms of
gold, and thus with an increase in the value of the gold dollar on

Monetary Stabilization and Cyclical Policy — 87

the basis of the index number. The social consequences of the
uneven timing of price changes would, therefore, not be avoided
because the unequal timing of the price changes of various com-
modities and services would not have been eliminated.

So there is no need to go into more detail with respect to the

technical difficulties that stand in the way of realizing Fisher’s
Plan. Even if it could be put into operation successfully, it would
not provide us with a monetary system that would leave the dis-
position of wealth and income undisturbed.

VI.

OODS

-I

NDUCED AND

ASH

-I

NDUCED

HANGES IN THE

URCHASING

OWER OF THE

ARKET

1. T

NHERENT

NSTABILITY OF

ARKET

ATIOS

Changes in the exchange ratios between money and the vari-

ous other commodities may originate either from the money side
or from the commodity side of the transaction. Stabilization pol-
icy does not aim only at eliminating changes arising on the side
of money. It also seeks to prevent all future price changes, even if
this is not always clearly expressed and may sometimes be dis-
puted.

It is not necessary for our purposes to go any further into the

market phenomena which an increase or decrease in commodities
must set in motion if the quantity of money remains unchanged.

It is sufficient to point out that, in addition to changes in the

88 — The Causes of the Economic Crisis

See also my critique of Fisher’s proposal in The Theory of Money and

Credit, pp. 403ff.; 1980, pp. 442ff.

Whether this is considered a change of purchasing power from the money

side or from the commodity side is purely a matter of terminology.

exchange ratios among individual commodities, shifts would also
appear in the exchange ratios between money and the majority of
the other commodities in the market. A decrease in the quantity of
other commodities would weaken the purchasing power of the
monetary unit. An increase would enhance it. It should be noted,
however, that the social adjustments which must result from these
changes in the quantity of other commodities will lead to a reor-
ganization in the demand for money and hence cash holdings.
These shifts can occur in such a way as to counteract the imme-
diate effect of the change in the quantity of goods on the
purchasing power of the monetary unit. Still for the time being,
we may ignore this situation.

The goal of all stabilization proposals, as we have seen, is to

maintain unchanged the original content of future monetary
obligations. Creditors and debtors should neither gain nor lose in
purchasing power. This is assumed to be “just.” Of course, what is
“just” or “unjust” cannot be scientifically determined. That is a
question of ultimate purpose and ethical judgment. It is not a
question of fact.

It is impossible to know just why the advocates of purchasing

power stabilization see as “just” only the maintenance of an
unchanged purchasing power for future monetary obligations.
However, it is easy to understand that they do not want to permit
either debtor or creditor to gain or lose. They want contractual
liabilities to continue in force as little altered as possible in the
midst of the constantly changing world economy. They want to
transplant contractual liabilities out of the flow of events, so to
speak, and into a timeless existence.

Now let us see what this means. Imagine that all production

has become more fruitful. Goods flow more abundantly than
ever before. Where only one unit was available for consumption
before, there are now two. Since the quantity of money has not
been increased, the purchasing power of the monetary unit has
risen and with one monetary unit it is possible to buy, let us say,
one-and-a-half times as much merchandise as before. Whether
this actually means, if no “stabilization policy” is attempted, that

Monetary Stabilization and Cyclical Policy — 89

the debtor now has a disadvantage and the creditor an advantage
is not immediately clear.

If you look at the situation from the viewpoint of the prices of

the factors of production, it is easy to see why this is the case. For
the debtor could use the borrowed sum to buy at lower prices fac-
tors of production whose output has not gone up; or if their
output has gone up, their prices have not risen correspondingly.
It might now be possible to buy for less money, factors of produc-
tion with a productive capacity comparable to that of the factors
of production one could have bought with the borrowed money
at the time of the loan. There is no point in exploring the
uncertainties of theories which do not take into consideration the
influence that ensuing changes exert on entrepreneurial profit,
interest and rent.

However, if we consider changes in real income due to

increased production, it becomes evident that the situation may
be viewed very differently from the way it appears to those who
favor “stabilization.” If the creditor gets back the same nominal
sum, he can obviously buy more goods. Still, his economic situa-
tion is not improved as a result. He is not benefited relative to the
general increase of real income which has taken place. If the mul-
tiple commodity standard were to reduce in part the nominal
debt, his economic situation would be worsened. He would be
deprived of something that, in his view, in all fairness belonged to
him. Under a multiple commodity standard, interest payable over
time, life annuities, subsistence allowances, pensions, and the
like, would be increased or decreased according to the index
number. Thus, these considerations cannot be summarily dis-
missed as irrelevant from the viewpoint of consumers.

We find, on the one hand, that neither the multiple commod-

ity standard nor Irving Fisher’s specific proposal is capable of
eliminating the economic concomitants of changes in the value of
the monetary unit due to the unequal timing in appearance and
the irregularity in size of price changes. On the other hand, we see
that these proposals seek to eliminate the repercussions on the
content of debt agreements, circumstances permitting, in such a
way as to cause definite shifts in wealth and income relations,

90 — The Causes of the Economic Crisis

shifts which appear obviously “unjust,” at least to those on whom
their burden falls. The “justice” of these proposed reforms, there-
fore, is somewhat more doubtful than their advocates are
inclined to assume.

2. T

ISPLACED

ARTIALITY TO

EBTORS

It is certainly regrettable that this worthy goal cannot be

attained, at least not by this particular route. These and similar
efforts are usually acknowledged with sympathy by many who
recognize their fallacy and their unworkability. This sympathy is
based ultimately on the intellectual and physical inclination of
men to be both lazy and resistant to change at the same time.
Surely everyone wants to see his situation improved with respect
to his supply of goods and the satisfaction of his wants. Surely
everyone hopes for changes which would make him richer. Many
circumstances make it appear that the old and the traditional,
being familiar, are preferable to the new. Such circumstances
would include distrust of the individual’s own powers and abili-
ties, aversion to being forced to adapt in thought and action to
new situations and, finally, the knowledge that one is no longer
able, in advanced years of life, to meet his obligations with the
vitality of youth.

Certainly, something new is welcomed and gratefully accepted,

if the something new is beneficial to the individual’s welfare.
However, any change which brings disadvantages or merely
appears to bring them, whether or not the change is to blame, is
considered “unjust.” Those favored by the new state of affairs
through no special merit on their part quietly accept the increased
prosperity as a matter of course and even as something already
long due. Those hurt by the change, however, complain vocifer-
ously. From such observations, there developed the concepts of a
“just price” and a ‘‘just wage.” Whoever fails to keep up with the
times and is unable to comply with its demands, becomes a eulo-
gist of the past and an advocate of the status quo. However, the
ideal of stability, of the stationary economy, is directly opposed to
that of continual progress.

Monetary Stabilization and Cyclical Policy — 91

For some time popular opinion has been in sympathy with the

debtor. The picture of the rich creditor, demanding payment
from the poor debtor, and the vindictive teachings of moralists
dominate popular thinking on indebtedness. A byproduct of this
is to be found in the contrast, made by the contemporaries of the
Classical School and their followers, between the “idle rich” and
the “industrious poor.” However, with the development of bonds
and savings deposits, and with the decline of small-scale enter-
prise and the rise of big business, a reversal of the former
situation took place. It then became possible for the masses, with
their increasing prosperity, to become creditors. The “rich man”
is no longer the typical creditor, nor the “poor man” the typical
debtor. In many cases, perhaps even in the majority of cases, the
relationship is completely reversed. Today, except in the lands of
farmers and small property owners, the debtor viewpoint is no
longer that of the masses. Consequently it is also no longer the
view of the political demagogues. Once upon a time inflation
may have found its strongest support among the masses, who
were burdened with debts. But the situation is now very different.
A policy of monetary restriction would not be unwelcome among
the masses today, for they would hope to reap a sure gain from it
as creditors. They would expect the decline in their wages and
salaries to lag behind, or at any rate not to exceed, the drop in
commodity prices.

It is understandable, therefore, that proposals for the creation

of a “stable value” standard of deferred payments, almost com-
pletely forgotten in the years when commodity prices were
declining, have been revived again in the twentieth century.
Proposals of this kind are always primarily intended for the pre-
vention of losses to creditors, hardly ever to safeguard
jeopardized debtor interests. They cropped up in England when
she was the great world banker. They turned up again in the
United States at the moment when she started to become a cred-
itor nation instead of a land of debtors, and they became quite
popular there when America became the great world creditor.

Many signs seem to indicate that the period of monetary

depreciation [due to inflation] is coming to an end. Should this

92 — The Causes of the Economic Crisis

actually be the case, then the appeal which the idea of a manipu-
lated standard now enjoys among creditor nations also would
abate.

VII.

OAL OF

ONETARY

OLICY

1. L

IBERALISM

AND THE

OLD

TANDARD

Monetary policy of the preliberal era was either crude coin

debasement, for the benefit of financial administration (only
rarely intended as Seisachtheia,

i.e., to nullify outstanding

debts), or still more crude paper money inflation. However, in
addition to, sometimes even instead of, its fiscal goal, the driving
motive behind paper money inflation very soon became the
desire to favor the debtor at the expense of the creditor.

In opposing the depreciated paper standard, liberalism fre-

quently took the position that after an inflation the value of paper
money should be raised, through contraction, to its former par-
ity with metallic money. It was only when men had learned that
such a policy could not undo or reverse the “unfair” changes in
wealth and income brought about by the previous inflationary
period and that an increase in the purchasing power per unit [by
contraction or deflation] also brings other unwanted shifts of
wealth and income, that the demand for return to a metallic stan-
dard at the debased monetary unit’s current parity gradually
replaced the demand for restoration at the old parity.

Monetary Stabilization and Cyclical Policy — 93

I.e., “classical liberalism.” See above, p. 68, note 11.

[In conversation, Professor Mises explained that this is a Greek term,

meaning “shaking off of burdens.” It was used in the seventh century B.C.
and later to describe measures enacted to cancel public and private debts,
completely or in part. Creditors then had to bear the burden, except to the
extent that they might be indemnified by the government. —Ed.]

In opposing a single precious metal standard, monetary policy

exhausted itself in the fruitless attempt to make bimetallism an
actuality. The results which must follow the establishment of a
legal exchange ratio between the two precious metals, gold and
silver, have long been known, even before Classical economics
developed an understanding of the regularity of market phenom-
ena. Again and again Gresham’s Law, which applied the general
theory of price controls to the special case of money, demon-
strated its validity. Eventually, efforts were abandoned to reach
the ideal of a bimetallic standard. The next goal then became to
free international trade, which was growing more and more
important, from the effects of fluctuations in the ratio between
the prices of the gold standard and the suppression of the alter-
nating [bimetallic] and silver standards. Gold then became the
world’s money.

With the attainment of gold monometallism, liberals believed

the goal of monetary policy had been reached. (The fact that
they considered it necessary to supplement monetary policy
through banking policy will be examined later in considerable
detail.) The value of gold was then independent of any direct
manipulation by governments, political policies, public opinion
or Parliaments. So long as the gold standard was maintained,
there was no need to fear severe price disturbances from the side
of money. The adherents of the gold standard wanted no more
than this, even though it was not clear to them at first that this
was all that could be attained.

2. “P

URE

” G

OLD

TANDARD

ISREGARDED

We have seen how the purchasing power of gold has continu-

ously declined since the turn of the century. That was not, as
frequently maintained, simply the consequence of increased gold
production. There is no way to know whether the increased pro-
duction of gold would have been sufficient to satisfy the
increased demand for money without increasing its purchasing
power, if monetary policy had not intervened as it did. The gold
exchange and flexible standards were adopted in a number of
countries, not the “pure” gold standard as its advocates had

94 — The Causes of the Economic Crisis

expected. “Pure” gold standard countries embraced measures
which were thought to be, and actually were, steps toward the
exchange standard. Finally, since 1914, gold has been withdrawn
from actual circulation almost everywhere. It is primarily due to
these measures that gold declined in value, thus generating the
current debate on monetary policy.

The fault found with the gold standard today is not, therefore,

due to the gold standard itself. Rather, it is the result of a policy
which deliberately seeks to undermine the gold standard in order
to lower the costs of using money and especially to obtain “cheap
money,” i.e., lower interest rates for loans. Obviously, this policy
cannot attain the goal it sets for itself. It must eventually bring
not low interest on loans but rather price increases and distortion
of economic development. In view of this, then, isn’t it simply
enough to abandon all attempts to use tricks of banking and
monetary policy to lower interest rates, to reduce the costs of
using and circulating money and to satisfy “needs” by promoting
paper inflation?

The “pure” gold standard formed the foundation of the mon-

etary system in the most important countries of Europe and
America, as well as in Australia. This system remained in force
until the outbreak of the World War [1914]. In the literature on
the subject, it was also considered the ideal monetary policy
until very recently. Yet the champions of this “pure” gold stan-
dard undoubtedly paid too little attention to changes in the
purchasing power of monetary gold originating on the side of
money. They scarcely noted the problem of the “stabilization” of
the purchasing power of money, very likely considering it com-
pletely impractical. Today we may pride ourselves on having
grasped the basic questions of price and monetary theory more
thoroughly and on having discarded many of the concepts which
dominated works on monetary policy of the recent past.
However, precisely because we believe we have a better under-
standing of the problem of value today, we can no longer
consider acceptable the proposals to construct a monetary sys-
tem based on index numbers.

Monetary Stabilization and Cyclical Policy — 95

3. T

NDEX

TANDARD

It is characteristic of current political thinking to welcome every

suggestion which aims at enlarging the influence of government. If
the Fisher and Keynes

proposals are approved on the grounds

that they are intended to use government to make the formation of
monetary value directly subservient to certain economic and polit-
ical ends, this is understandable. However, anyone who approves of
the index standard, because he wants to see purchasing power “sta-
bilized,” will find himself in serious error.

Abandoning the pursuit of the chimera of a money of

unchanging purchasing power calls for neither resignation nor
disregard of the social consequences of changes in monetary
value. The necessary conclusion from this discussion is that sta-
bility of the purchasing power of the monetary unit presumes
stability of all exchange relationships and, therefore, the absolute
abandonment of the market economy.

The question has been raised again and again: What will

happen if, as a result of a technological revolution, gold produc-
tion should increase to such an extent as to make further
adherence to the gold standard impossible? A changeover to the
index standard must follow then, it is asserted, so that it would
only be expedient to make this change voluntarily now.
However, it is futile to deal with monetary problems today
which may or may not arise in the future. We do not know
under what conditions steps will have to be taken toward solv-
ing them. It could be that, under certain circumstances, the
solution may be to adopt a system based on an index number.
However, this would appear doubtful. Even so, an index stan-
dard would hardly be a more suitable monetary standard than
the one we now have. In spite of all its defects, the gold standard
is a useful and not inexpedient standard.

96 — The Causes of the Economic Crisis

Keynes’s 1923 proposal, A Tract on Monetary Reform.

ART

YCLICAL

OLICY TO

LIMINATE

CONOMIC

LUCTUATIONS

TABILIZATION OF THE

URCHASING

OWER OF

ONETARY

NIT

AND

LIMINATION OF THE

RADE

YCLE

1. C

URRENCY

CHOOL

’

ONTRIBUTION

tabilization” of the purchasing power of the monetary unit
would also lead, at the same time, to the ideal of an econ-
omy without any changes. In the stationary economy there

would be no “ups” and “downs” of business. Then, the sequence
of events would flow smoothly and steadily. Then, no unforeseen
event would interrupt the provisioning of goods. Then, the act-
ing individual would experience no disillusionment because
events did not develop as he had assumed in planning his affairs
to meet future demands.

First, we have seen that this ideal cannot be realized. Second,

we have seen that this ideal is generally proposed as a goal only
because the problems involved in the formation of purchasing
power have not been thought through completely. Finally, we have
seen that even if a stationary economy could actually be realized,
it would certainly not accomplish what had been expected. Yet
neither these facts nor the limiting of monetary policy to the
maintenance of a “pure” gold standard mean that the political slo-
gan, “Eliminate the business cycle,” is without value.

It is true that some authors, who dealt with these problems,

had a rather vague idea that the “stabilization of the price level”
was the way to attain the goals they set for cyclical policy. Yet

Monetary Stabilization and Cyclical Policy — 97

“

cyclical policy was not completely spent on fruitless attempts to
fix the purchasing power of money. Witness the fact that steps
were undertaken to curb the boom through banking policy, and
thus to prevent the decline, which inevitably follows the upswing,
from going as far as it would if matters were allowed to run their
course. These efforts—undertaken with enthusiasm at a time
when people did not realize that anything like stabilization of
monetary value would ever be conceived of and sought after—led
to measures that had far-reaching consequences.

We should not forget for a moment the contribution which

the Currency School made to the clarification of our problem.
Not only did it contribute theoretically and scientifically but it
contributed also to practical policy. The recent theoretical treat-
ment of the problem—in the study of events and statistical data
and in politics—rests entirely on the accomplishments of the
Currency School. We have not surpassed Lord Overstone

so far

as to be justified in disparaging his achievement.

Many modern students of cyclical movements are contemptu-

ous of theory—not only of this or that theory but of all
theories—and profess to let the facts speak for themselves. The
delusion that theory must be distilled from the results of an
impartial investigation of facts is more popular in cyclical theory
than in any other field of economics. Yet, nowhere else is it
clearer that there can be no understanding of the facts without
theory.

Certainly it is no longer necessary to expose once more the

errors in logic of the Historical-Empirical-Realistic approach to
the “social sciences.”

Only recently has this task been most thor-

oughly undertaken once more by competent scholars.
Nevertheless, we continually encounter attempts to deal with the
business cycle problem while presumably rejecting theory.

98 — The Causes of the Economic Crisis

[Lord Samuel Jones Loyd Overstone (1796–1883) was an early oppo-

nent of inconvertible paper money and a leading proponent of the
principles of the Peel’s Act of 1844.—Ed.]

[See Theory and History (1957; 1969; Auburn, Ala.: Ludwig von Mises

Institute, 1985).—Ed.]

In taking this approach one falls prey to a delusion which is

incomprehensible. It is assumed that data on economic fluctua-
tions are given clearly, directly and in a way that cannot be
disputed. Thus it remains for science merely to interpret these
fluctuations—and for the art of politics simply to find ways and
means to eliminate them.

2. E

ARLY

RADE

YCLE

HEORIES

All business establishments do well at times and badly at oth-

ers. There are times when the entrepreneur sees his profits
increase daily more than he had anticipated and when, embold-
ened by these “windfalls,” he proceeds to expand his operations.
Then, due to an abrupt change in conditions, severe disillusion-
ment follows this upswing, serious losses materialize, long
established firms collapse, until widespread pessimism sets in
which may frequently last for years. Such were the experiences
which had already been forced on the attention of the business-
man in capitalistic economies, long before discussions of the
crisis problem began to appear in the literature. The sudden turn
from the very sharp rise in prosperity—at least what appeared to
be prosperity—to a very severe drop in profit opportunities was
too conspicuous not to attract general attention. Even those who
wanted to have nothing to do with the business world’s “worship
of filthy lucre” could not ignore the fact that people who were, or
had been considered, rich yesterday were suddenly reduced to
poverty, that factories were shut down, that construction projects
were left uncompleted, and that workers could not find work.
Naturally, nothing concerned the businessman more intimately
than this very problem.

If an entrepreneur is asked what is going on here—leaving

aside changes in the prices of individual commodities due to rec-
ognizable causes—he may very well reply that at times the entire
“price level” tends upward and then at other times it tends down-
ward. For inexplicable reasons, he would say, conditions arise
under which it is impossible to dispose of all commodities, or
almost all commodities, except at a loss. And what is most curi-
ous is that these depressing times always come when least

Monetary Stabilization and Cyclical Policy — 99

expected, just when all business had been improving for some
time so that people finally believed that a new age of steady and
rapid progress was emerging.

Eventually, it must have become obvious to the more keenly

thinking businessman that the genesis of the crisis should be
sought in the preceding boom. The scientific investigator, whose
view is naturally focused on the longer period, soon realized that
economic upswings and downturns alternated with seeming reg-
ularity. Once this was established, the problem was halfway
exposed and scientists began to ask questions as to how this
apparent regularity might be explained and understood.

Theoretical analysis was able to reject, as completely false, two

attempts to explain the crisis—the theories of general overpro-
duction and of underconsumption. These two doctrines have
disappeared from serious scientific discussion. They persist
today only outside the realm of science—the theory of general
overproduction, among the ideas held by the average citizen; and
the underconsumption theory, in Marxist literature.

It was not so easy to criticize a third group of attempted expla-

nations, those which sought to trace economic fluctuations back
to periodic changes in natural phenomena affecting agricultural
production. These doctrines cannot be reached by theoretical
inquiry alone. Conceivably such events may occur and reoccur at
regular intervals. Whether this actually is the case can be shown
only by attempts to verify the theory through observation. So far,
however, none of these “weather theories”

has successfully

passed this test.

A whole series of a very different sort of attempts to explain

the crisis are based on a definite irregularity in the psychological
and intellectual talents of people. This irregularity is expressed in
the economy by a change from confidence over the future, which

100 — The Causes of the Economic Crisis

[Regarding the theories of William Stanley Jevons, Henry L. Moore and

William Beveridge, see Wesley Clair Mitchell’s Business Cycles (New York:
National Bureau of Economic Research, 1927), pp. 12ff.—Ed.]

inspires the boom, to despondency, which leads to the crisis and
to stagnation of business. Or else this irregularity appears as a
shift from boldly striking out in new directions to quietly follow-
ing along already well-worn paths.

What should be pointed out about these doctrines and about

the many other similar theories based on psychological varia-
tions is, first of all, that they do not explain. They merely pose the
problem in a different way. They are not able to trace the change
in business conditions back to a previously established and iden-
tified phenomenon. From the periodical fluctuations in
psychological and intellectual data alone, without any further
observation concerning the field of labor in the social or other
sciences, we learn that such economic shifts as these may also be
conceived of in a different way. So long as the course of such
changes appears plausible only because of economic fluctuations
between boom and bust, psychological and other related theories
of the crisis amount to no more than tracing one unknown factor
back to something else equally unknown.

3. T

IRCULATION

REDIT

HEORY

Of all the theories of the trade cycle, only one has achieved

and retained the rank of a fully-developed economic doctrine.
That is the theory advanced by the Currency School, the theory
which traces the cause of changes in business conditions to the
phenomenon of circulation credit. All other theories of the crisis,
even when they try to differ in other respects from the line of rea-
soning adopted by the Currency School, return again and again
to follow in its footsteps. Thus, our attention is constantly being
directed to observations which seem to corroborate the
Currency School’s interpretation.

In fact, it may be said that the Circulation Credit Theory of the

Trade Cycle

is now accepted by all writers in the field and that

Monetary Stabilization and Cyclical Policy — 101

As mentioned above, the most commonly used name for this theory is

the “monetary theory.” For a number of reasons the designation “circula-
tion credit theory” is preferable.

the other theories advanced today aim only at explaining why the
volume of circulation credit granted by the banks varies from
time to time. All attempts to study the course of business fluctu-
ations empirically and statistically, as well as all efforts to
influence the shape of changes in business conditions by political
action, are based on the Circulation Credit Theory of the Trade
Cycle.

To show that an investigation of business cycles is not dealing

with an imaginary problem, it is necessary to formulate a cycle
theory that recognizes a cyclical regularity of changes in business
conditions. If we could not find a satisfactory theory of cyclical
changes, then the question would remain as to whether or not
each individual crisis arose from a special cause which we would
have to track down first. Originally, economics approached the
problem of the crisis by trying to trace all crises back to specific
“visible” and “spectacular” causes such as war, cataclysms of
nature, adjustments to new economic data—for example, changes
in consumption and technology, or the discovery of easier and
more favorable methods of production. Crises which could not be
explained in this way became the specific “problem of the crisis.”

Neither the fact that unexplained crises still recur again

and again nor the fact that they are always preceded by a distinct
boom period is sufficient to prove with certainty that the
problem to be dealt with is a unique phenomenon originating
from one specific cause. Recurrences do not appear at regular
intervals. And it is not hard to believe that the more a crisis con-
trasts with conditions in the immediately preceding period, the
more severe it is considered to be. It might be assumed, therefore,
that there is no specific “problem of the crisis” at all, and that the
still unexplained crises must be explained by various special
causes somewhat like the “crisis” which Central European agri-
culture has faced since the rise of competition from the tilling of
richer soil in Eastern Europe and overseas, or the “crisis” of the
European cotton industry at the time of the American Civil War.
What is true of the crisis can also be applied to the boom. Here
again, instead of seeking a general boom theory we could look for
special causes for each individual boom.

102 — The Causes of the Economic Crisis

Neither the connection between boom and bust nor the cycli-

cal change of business conditions is a fact that can be established
independent of theory. Only theory, business cycle theory, per-
mits us to detect the wavy outline of a cycle in the tangled
confusion of events.

II.

IRCULATION

REDIT

HEORY

1. T

ANKING

CHOOL

ALLACY

If notes are issued by the banks, or if bank deposits subject to

check or other claim are opened, in excess of the amount of money
kept in the vaults as cover, the effect on prices is similar to that
obtained by an increase in the quantity of money. Since these fiduci-
ary media, as notes and bank deposits not backed by metal are called,
render the service of money as safe and generally accepted, payable
on demand monetary claims, they may be used as money in all trans-
actions. On that account, they are genuine money substitutes. Since
they are in excess of the given total quantity of money in the narrower
sense, they represent an increase in the quantity of money in the
broader sense.

The practical significance of these undisputed and indis-

putable conclusions in the formation of prices is denied by the
Banking School with its contention that the issue of such fidu-
ciary media is strictly limited by the demand for money in the
economy. The Banking School doctrine maintains that if fiduci-
ary media are issued by the banks only to discount short-term
commodity bills, then no more would come into circulation

Monetary Stabilization and Cyclical Policy — 103

If expressions such as cycle, wave, etc., are used in business cycle the-

ory, they are merely illustrations to simplify the presentation. One cannot
and should not expect more from a simile which, as such, must always fall
short of reality.

than were “needed” to liquidate the transactions. According to
this doctrine, bank management could exert no influence on
the volume of the commodity transactions activated. Purchases
and sales from which short-term commodity bills originate
would, by this very transaction, already have brought into exis-
tence paper credit which can be used, through further
negotiation, for the exchange of goods and services. If the bank
discounts the bill and, let us say, issues notes against it, that is,
according to the Banking School, a neutral transaction as far as
the market is concerned. Nothing more is involved than replac-
ing one instrument which is technically less suitable for
circulation, the bill of exchange, with a more suitable one, the
note. Thus, according to this School, the effect of the issue of
notes need not be to increase the quantity of money in circula-
tion. If the bill of exchange is retired at maturity, then notes
would flow back to the bank and new notes could enter circula-
tion again only when new commodity bills came into being
once more as a result of new business.

The weak link in this well-known line of reasoning lies in the

assertion that the volume of transactions completed, as sales
and purchases from which commodity bills can derive, is inde-
pendent of the behavior of the banks. If the banks discount at a
lower, rather than at a higher, interest rate, then more loans are
made. Enterprises which are unprofitable at 5 percent, and
hence are not undertaken, may be profitable at 4 percent.
Therefore, by lowering the interest rate they charge, banks can
intensify the demand for credit. Then, by satisfying this
demand, they can increase the quantity of fiduciary media in
circulation. Once this is recognized, the Banking Theory’s only
argument, that prices are not influenced by the issue of fiduci-
ary media, collapses.

One must be careful not to speak simply of the effects of

credit in general on prices, but to specify clearly the effects of
“increased credit” or “credit expansion.” A sharp distinction
must be made between (1) credit which a bank grants by lend-
ing its own funds or funds placed at its disposal by depositors,
which we call “commodity credit,” and (2) that which is granted

104 — The Causes of the Economic Crisis

by the creation of fiduciary media, i.e., notes and deposits not
covered by money, which we call “circulation credit.”

It is only

through the granting of circulation credit that the prices of all
commodities and services are directly affected.

If the banks grant circulation credit by discounting a three

month bill of exchange, they exchange a future good—a claim
payable in three months—for a present good that they produce
out of nothing. It is not correct, therefore, to maintain that it is
immaterial whether the bill of exchange is discounted by a bank
of issue or whether it remains in circulation, passing from hand
to hand. Whoever takes the bill of exchange in trade can do so
only if he has the resources. But the bank of issue discounts by
creating the necessary funds and putting them into circulation.
To be sure, the fiduciary media flow back again to the bank at
expiration of the note. If the bank does not give the fiduciary
media out again, precisely the same consequences appear as
those which come from a decrease in the quantity of money in
its broader sense.

2. E

ARLY

FFECTS OF

REDIT

XPANSION

The fact that in the regular course of banking operations the

banks issue fiduciary media only as loans to producers and mer-
chants means that they are not used directly for purposes of
consumption.

Rather, these fiduciary media are used first of all

for production, that is to buy factors of production and pay
wages. The first prices to rise, therefore, as a result of an increase
of the quantity of money in the broader sense, caused by the issue
of such fiduciary media, are those of raw materials, semimanu-
factured products, other goods of higher orders, and wage rates.

Monetary Stabilization and Cyclical Policy — 105

[For further explanation of the distinction between “commodity credit”

and “circulation credit” see Mises’s 1946 essay “The Trade Cycle and Credit
Expansion: The Economic Consequences of Cheap Money” included later
in this volume, especially, pp. 193–94.—Ed.]

[In 1928, fiduciary media were issued only by discounting what Mises

called commodity bills, or short-term (90 days or less) bills of exchange
endorsed by a buyer and a seller and constituting a lien on the goods sold.
—Ed.]

Only later do the prices of goods of the first order [consumers’
goods] follow. Changes in the purchasing power of a monetary
unit, brought about by the issue of fiduciary media, follow a dif-
ferent path and have different accompanying social side effects
from those produced by a new discovery of precious metals or by
the issue of paper money. Still in the last analysis, the effect on
prices is similar in both instances.

Changes in the purchasing power of the monetary unit do not

directly affect the height of the rate of interest. An indirect influ-
ence on the height of the interest rate can take place as a result of
the fact that shifts in wealth and income relationships, appearing
as a result of the change in the value of the monetary unit, influ-
ence savings and, thus, the accumulation of capital. If a
depreciation of the monetary unit favors the wealthier members
of society at the expense of the poorer, its effect will probably be
an increase in capital accumulation since the well-to-do are the
more important savers. The more they put aside, the more their
incomes and fortunes will grow.

If monetary depreciation is brought about by an issue of fidu-

ciary media, and if wage rates do not promptly follow the
increase in commodity prices, then the decline in purchasing
power will certainly make this effect much more severe. This is
the “forced savings” which is quite properly stressed in recent lit-
erature.

However, three things should not be forgotten. First, it

always depends upon the data of the particular case whether
shifts of wealth and income, which lead to increased saving, are

106 — The Causes of the Economic Crisis

Albert Hahn and Joseph Schumpeter have given me credit for the

expression “forced savings” or “compulsory savings.” See Hahn’s article on
“Credit” in Handwörterbuch der Staatswissenschaften (4th ed., vol. V, p.
951) and Schumpeter’s The Theory of Economic Development (2nd German
language ed., 1926 [English translation, Harvard University Press, 1934), p.
109n.]). To be sure, I described the phenomenon in 1912 in the first
German language edition of The Theory of Money and Credit [see 1953, pp.
208ff. and 347ff.; 1980, pp. 238ff. and 385ff. of the English translations].
However, I do not believe the expression itself was actually used there.

actually set in motion. Second, under circumstances which need
not be discussed further here, by falsifying economic calculation,
based on monetary bookkeeping calculations, a very substantial
devaluation can lead to capital consumption (such a situation did
take place temporarily during the recent inflationary period).
Third, as advocates of inflation through credit expansion should
observe, any legislative measure which transfers resources to the
“rich” at the expense of the “poor” will also foster capital forma-
tion.

Eventually, the issue of fiduciary media in such manner can

also lead to increased capital accumulation within narrow limits
and, hence, to a further reduction of the interest rate. In the
beginning, however, an immediate and direct decrease in the
loan rate appears with the issue of fiduciary media, but this
immediate decrease in the loan rate is distinct in character and
degree from the later reduction. The new funds offered on the
money market by the banks must obviously bring pressure to
bear on the rate of interest. The supply and demand for loan
money were adjusted at the interest rate prevailing before the
issue of any additional supply of fiduciary media. Additional
loans can be placed only if the interest rate is lowered. Such loans
are profitable for the banks because the increase in the supply of
fiduciary media calls for no expenditure except for the mechani-
cal costs of banking (i.e., printing the notes and bookkeeping).
The banks can, therefore, undercut the interest rates which
would otherwise appear on the loan market, in the absence of
their intervention. Since competition from them compels other
money lenders to lower their interest charges, the market inter-
est rate must therefore decline. But can this reduction be
maintained? That is the problem.

3. I

NEVITABLE

FFECTS OF

REDIT

XPANSION

NTEREST

ATES

In conformity with Wicksell’s terminology, we shall use “natu-

ral interest rate” to describe that interest rate which would be
established by supply and demand if real goods were loaned in
natura [directly, as in barter] without the intermediary of money.

Monetary Stabilization and Cyclical Policy — 107

108 — The Causes of the Economic Crisis

“Money rate of interest” will be used for that interest rate asked
on loans made in money or money substitutes. Through contin-
ued expansion of fiduciary media, it is possible for the banks to
force the money rate down to the actual cost of the banking oper-
ations, practically speaking that is almost to zero. As a result,
several authors have concluded that interest could be completely
abolished in this way. Whole schools of reformers have wanted to
use banking policy to make credit gratuitous and thus to solve the
“social question.” No reasoning person today, however, believes
that interest can ever be abolished, nor doubts but what, if the
“money interest rate” is depressed by the expansion of fiduciary
media, it must sooner or later revert once again to the “natural
interest rate.” The question is only how this inevitable adjustment
takes place. The answer to this will explain at the same time the
fluctuations of the business cycle.

The Currency Theory limited the problem too much. It only

considered the situation that was of practical significance for the
England of its time—that is, when the issue of fiduciary media is
increased in one country while remaining unchanged in others.
Under these assumptions, the situation is quite clear: General
price increases at home; hence an increase in imports, a drop in
commodity exports; and with this, as notes can circulate only
within the country, an outflow of metallic money. To obtain
metallic money for export, holders of notes present them for
redemption; the metallic reserves of the banks decline; and con-
sideration for their own solvency then forces them to restrict the
credit offered.

That is the instant at which the business upswing, brought

about by the availability of easy credit, is demonstrated to be illu-
sory prosperity. An abrupt reaction sets in. The “money rate of
interest” shoots up; enterprises from which credit is withdrawn
collapse and sweep along with them the banks which are their
creditors. A long persisting period of business stagnation now
follows. The banks, warned by this experience into observing
restraint, not only no longer underbid the “natural interest rate”
but exercise extreme caution in granting credit.

Monetary Stabilization and Cyclical Policy — 109

4. T

RICE

REMIUM

In order to complete this interpretation, we must, first of all,

consider the price premium. As the banks start to expand the cir-
culation credit, the anticipated upward movement of prices
results in the appearance of a positive price premium. Even if the
banks do not lower the actual interest rate any more, the gap
widens between the “money interest rate” and the “natural inter-
est rate” which would prevail in the absence of their intervention.
Since loan money is now cheaper to acquire than circumstances
warrant, entrepreneurial ambitions expand.

New businesses are started in the expectation that the neces-

sary capital can be secured by obtaining credit. To be sure, in the
face of growing demand, the banks now raise the “money interest
rate.” Still they do not discontinue granting further credit. They
expand the supply of fiduciary media issued, with the result that
the purchasing power of the monetary unit must decline still fur-
ther. Certainly the actual “money interest rate” increases during
the boom, but it continues to lag behind the rate which would
conform to the market, i.e., the “natural interest rate” augmented
by the positive price premium.

So long as this situation prevails, the upswing continues.

Inventories of goods are readily sold. Prices and profits rise.
Business enterprises are overwhelmed with orders because
everyone anticipates further price increases and workers find
employment at increasing wage rates. However, this situation
cannot last forever!

5. M

ALINVESTMENT OF

VAILABLE

APITAL

OODS

The “natural interest rate” is established at that height which

tends toward equilibrium on the market. The tendency is toward
a condition where no capital goods are idle, no opportunities for
starting profitable enterprises remain unexploited and the only
projects not undertaken are those which no longer yield a profit
at the prevailing “natural interest rate.” Assume, however, that the
equilibrium, toward which the market is moving, is disturbed by
the interference of the banks. Money may be obtained below the

110 — The Causes of the Economic Crisis

“natural interest rate.” As a result businesses may be started
which weren’t profitable before, and which become profitable
only through the lower than “natural interest rate” which appears
with the expansion of circulation credit.

Here again, we see the difference which exists between a drop

in purchasing power, caused by the expansion of circulation
credit, and a loss of purchasing power, brought about by an
increase in the quantity of money. In the latter case [i.e., with an
increase in the quantity of money in the narrower sense] the
prices first affected are either (1) those of consumers’ goods only
or (2) the prices of both consumers’ and producers’ goods. Which
it will be depends on whether those first receiving the new quan-
tities of money use this new wealth for consumption or
production. However, if the decrease in purchasing power is
caused by an increase in bank created fiduciary media, then it is
the prices of producers’ goods which are first affected. The prices
of consumers’ goods follow only to the extent that wages and
profits rise.

Since it always requires some time for the market to reach full

“equilibrium,” the “static” or “natural”

prices, wage rates and

interest rates never actually appear. The process leading to their
establishment is never completed before changes occur which
once again indicate a new “equilibrium.” At times, even on the
unhampered market, there are some unemployed workers,
unsold consumers’ goods and quantities of unused factors of pro-
duction, which would not exist under “static equilibrium.” With
the revival of business and productive activity, these reserves are
in demand right away. However, once they are gone, the increase
in the supply of fiduciary media necessarily leads to disturbances
of a special kind.

In a given economic situation, the opportunities for produc-

tion, which may actually be carried out, are limited by the supply
of capital goods available. Roundabout methods of production
can be adopted only so far as the means for subsistence exist to
maintain the workers during the entire period of the expanded

In the language of Knut Wicksell and the classical economists.

Monetary Stabilization and Cyclical Policy — 111

process. All those projects, for the completion of which means
are not available, must be left uncompleted, even though they
may appear technically feasible—that is, if one disregards the
supply of capital. However, such businesses, because of the lower
loan rate offered by the banks, appear for the moment to be prof-
itable and are, therefore, initiated. However, the existing
resources are insufficient. Sooner or later this must become evi-
dent. Then it will become apparent that production has gone
astray, that plans were drawn up in excess of the economic means
available, that speculation, i.e., activity aimed at the provision of
future goods, was misdirected.

6. “F

ORCED

AVINGS

”

In recent years, considerable significance has been attributed

to the fact that “forced savings,” which may appear as a result of
the drop in purchasing power that follows an increase of fiduci-
ary media, leads to an increase in the supply of capital. The
subsistence fund is made to go farther, due to the fact that (1) the
workers consume less because wage rates tend to lag behind the
rise in the prices of commodities, and (2) those who reap the
advantage of this reduction in the workers’ incomes save at least
a part of their gain. Whether “forced savings” actually appear
depends, as noted above, on the circumstances in each case.
There is no need to go into this any further.

Nevertheless, establishing the existence of “forced savings”

does not mean that bank expansion of circulation credit does not
lead to the initiation of more roundabout production than avail-
able capabilities would warrant. To prove that, one must be able
to show that the banks are only in a position to depress the
“money interest rate” and expand the issue of fiduciary media to
the extent that the “natural interest rate” declines as a result of
“forced savings.” This assumption is simply absurd and there is no
point in arguing it further. It is almost inconceivable that anyone
should want to maintain it.

What concerns us is the problem brought about by the banks,

in reducing the “money rate of interest” below the “natural rate.”
For our problem, it is immaterial how much the “natural interest

112 — The Causes of the Economic Crisis

rate” may also decline under certain circumstances and within
narrow limits, as a result of this action by the banks. No one
doubts that “forced savings” can reduce the “natural interest rate”
only fractionally, as compared with the reduction in the “money
interest rate” which produces the “forced savings.”

The resources which are claimed for the newly initiated longer

time consuming methods of production are unavailable for those
processes where they would otherwise have been put to use. The
reduction in the loan rate benefits all producers, so that all pro-
ducers are now in a position to pay higher wage rates and higher
prices for the material factors of production. Their competition
drives up wage rates and the prices of the other factors of produc-
tion. Still, except for the possibilities already discussed, this does
not increase the size of the labor force or the supply of available
goods of the higher order. The means of subsistence are not suf-
ficient to provide for the workers during the extended period of
production. It becomes apparent that the proposal for the new,
longer, roundabout production was not adjusted with a view to
the actual capital situation. For one thing, the enterprises realize
that the resources available to them are not sufficient to continue
their operations. They find that “money” is scarce.

That is precisely what has happened. The general increase in

prices means that all businesses need more funds than had been
anticipated at their “launching.” More resources are required to
complete them. However, the increased quantity of fiduciary
media loaned out by the banks is already exhausted. The banks
can no longer make additional loans at the same interest rates. As
a result, they must raise the loan rate once more for two reasons.
In the first place, the appearance of the positive price premium
forces them to pay higher interest for outside funds which they

I believe this should be pointed out here again, although I have

exhausted everything to be said on the subject (pp. 105–07) and in The
Theory of Money and Credit [1953, pp. 361ff.; 1980, pp. 400ff.]. Anyone
who has followed the discussions of recent years will realize how important
it is to stress these things again and again.

Monetary Stabilization and Cyclical Policy — 113

borrow. Then also, they must discriminate among the many
applicants for credit. Not all enterprises can afford this increased
interest rate. Those which cannot run into difficulties.

7. A H

ABIT

FORMING

OLICY

Now, in extending circulation credit, the banks do not pro-

ceed by pumping a limited dosage of new fiduciary media into
circulation and then stop. They expand the fiduciary media con-
tinuously for some time, sending, so to speak, after the first
offering, a second, third, fourth, and so on. They do not simply
undercut the “natural interest rate” once, and then adjust
promptly to the new situation. Instead they continue the practice
of making loans below the “natural interest rate” for some time.
To be sure, the increasing volume of demands on them for credit
may cause them to raise the “money rate of interest.” Yet, even if
the banks revert to the former “natural rate,” the rate which pre-
vailed before their credit expansion affected the market, they still
lag behind the rate which would now exist on the market if they
were not continuing to expand credit. This is because a positive
price premium must now be included in the new “natural rate.”
With the help of this new quantity of fiduciary media, the banks
now take care of the businessman's intensified demand for credit.
Thus, the crisis does not appear yet. The enterprises using more
roundabout methods of production, which have been started, are
continued. Because prices rise still further, the earlier calcula-
tions of the entrepreneurs are realized. They make profits. In
short, the boom continues.

8. T

NEVITABLE

RISIS AND

YCLE

The crisis breaks out only when the banks alter their conduct

to the extent that they discontinue issuing any more new fiduciary
media and stop undercutting the “natural interest rate.” They may
even take steps to restrict circulation credit. When they actually
do this, and why, is still to be examined. First of all, however, we
must ask ourselves whether it is possible for the banks to stay on
the course upon which they have embarked, permitting new
quantities of fiduciary media to flow into circulation continuously

114 — The Causes of the Economic Crisis

and proceeding always to make loans below the rate of interest
which would prevail on the market in the absence of their inter-
ference with newly created fiduciary media.

If the banks could proceed in this manner, with businesses

improving continually, could they then provide for lasting good
times? Would they then be able to make the boom eternal?

They cannot do this. The reason they cannot is that inflation-

ism carried on ad infinitum is not a workable policy. If the issue
of fiduciary media is expanded continuously, prices rise ever
higher and at the same time the positive price premium also rises.
(We shall disregard the fact that consideration for (1) the contin-
ually declining monetary reserves relative to fiduciary media and
(2) the banks’ operating costs must sooner or later compel them
to discontinue the further expansion of circulation credit.) It is
precisely because, and only because, no end to the prolonged
“flood” of expanding fiduciary media is foreseen, that it leads to
still sharper price increases and, finally, to a panic in which prices
and the loan rate move erratically upward.

Suppose the banks still did not want to give up the race?

Suppose, in order to depress the loan rate, they wanted to satisfy
the continuously expanding desire for credit by issuing still more
circulation credit? Then they would only hasten the end, the col-
lapse of the entire system of fiduciary media. The inflation can
continue only so long as the conviction persists that it will one
day cease. Once people are persuaded that the inflation will not
stop, they turn from the use of this money. They flee then to “real
values,” foreign money, the precious metals, and barter.

Sooner or later, the crisis must inevitably break out as the

result of a change in the conduct of the banks. The later the
crack-up comes, the longer the period in which the calculation of
the entrepreneurs is misguided by the issue of additional fiduci-
ary media. The greater this additional quantity of fiduciary
money, the more factors of production have been firmly commit-
ted in the form of investments which appeared profitable only
because of the artificially reduced interest rate and which prove to
be unprofitable now that the interest rate has again been raised.

Monetary Stabilization and Cyclical Policy — 115

Great losses are sustained as a result of misdirected capital invest-
ments. Many new structures remain unfinished. Others, already
completed, close down operations. Still others are carried on
because, after writing off losses which represent a waste of capital,
operation of the existing structure pays at least something.

The crisis, with its unique characteristics, is followed by stag-

nation. The misguided enterprises and businesses of the boom
period are already liquidated. Bankruptcy and adjustment have
cleared up the situation. The banks have become cautious. They
fight shy of expanding circulation credit. They are not inclined to
give an ear to credit applications from schemers and promoters.
Not only is the artificial stimulus to business, through the expan-
sion of circulation credit, lacking, but even businesses which
would be feasible, considering the capital goods available, are not
attempted because the general feeling of discouragement makes
every innovation appear doubtful. Prevailing “money interest
rates” fall below the “natural interest rates.”

When the crisis breaks out, loan rates bound sharply upward

because threatened enterprises offer extremely high interest rates
for the funds to acquire the resources, with the help of which they
hope to save themselves. Later, as the panic subsides, a situation
develops, as a result of the restriction of circulation credit and
attempts to dispose of large inventories, causing prices [and the
“money interest rate”] to fall steadily and leading to the appear-
ance of a negative price premium. This reduced rate of loan
interest is adhered to for some time, even after the decline in
prices comes to a standstill, when a negative price premium no
longer corresponds to conditions. Thus, it comes about that the
“money interest rate” is lower than the “natural rate.” Yet, because
the unfortunate experiences of the recent crisis have made every-
one uneasy, the incentive to business activity is not as strong as
circumstances would otherwise warrant. Quite a time passes
before capital funds, increased once again by savings accumu-
lated in the meantime, exert sufficient pressure on the loan
interest rate for an expansion of entrepreneurial activity to
resume. With this development, the low point is passed and the
new boom begins.

116 — The Causes of the Economic Crisis

III.

EAPPEARANCE OF

YCLES

1. M

ETALLIC

TANDARD

LUCTUATIONS

From the instant when the banks start expanding the volume

of circulation credit, until the moment they stop such behavior,
the course of events is substantially similar to that provoked by
any increase in the quantity of money. The difference results
from the fact that fiduciary media generally come into circulation
through the banks, i.e., as loans, while increases in the quantity of
money appear as additions to the wealth and income of specific
individuals. This has already been mentioned and will not be fur-
ther considered here. Considerably more significant for us is
another distinction between the two.

Such increases and decreases in the quantity of money have

no connection with increases or decreases in the demand for
money. If the demand for money grows in the wake of a popula-
tion increase or a progressive reduction of barter and
self-sufficiency resulting in increased monetary transactions,
there is absolutely no need to increase the quantity of money. It
might even decrease. In any event, it would be most extraordi-
nary if changes in the demand for money were balanced by
reciprocal changes in its quantity so that both changes were con-
cealed and no change took place in the monetary unit’s
purchasing power.

Changes in the value of the monetary unit are always taking

place in the economy. Periods of declining purchasing power
alternate with those of increasing purchasing power. Under a
metallic standard, these changes are usually so slow and so
insignificant that their effect is not at all violent. Nevertheless, we
must recognize that even under a precious metal standard periods
of ups and downs would still alternate at irregular intervals. In
addition to the standard metallic money, such a standard would
recognize only token coins for petty transactions. There would,

Monetary Stabilization and Cyclical Policy — 117

of course, be no paper money or any other currency (i.e., either
notes or bank accounts subject to check which are not fully cov-
ered). Yet even then, one would be able to speak of economic
“ups,” “downs” and “waves.” However, one would hardly be
inclined to refer to such minor alternating “ups” and “downs” as
regularly recurring cycles. During these periods when purchas-
ing power moved in one direction, whether up or down, it
would probably move so slightly that businessmen would
scarcely notice the changes. Only economic historians would
become aware of them. Moreover, the fact is that the transition
from a period of rising prices to one of falling prices would be
so slight that neither panic nor crisis would appear. This would
also mean that businessmen and news reports of market activi-
ties would be less occupied with the “long waves” of the trade
cycle.

2. I

NFREQUENT

ECURRENCES OF

APER

ONEY

NFLATIONS

The effects of inflations brought about by increases in paper

money are quite different. They also produce price increases and
hence “good business conditions,” which are further intensified
by the apparent encouragement of exports and the hampering of
imports. Once the inflation comes to an end, whether by a prov-
idential halt to further increases in the quantity of money (as for
instance recently in France and Italy) or through complete
debasement of the paper money due to inflationary policy car-
ried to its final conclusions (as in Germany in 1923), then the

To avoid misunderstanding, it should be pointed out that the expres-

sion “long-waves” of the trade cycle is not to be understood here as it was
used by either Wilhelm Röpke or N.D. Kondratieff. Röpke (Die Konjunktur
[Jena, 1922], p. 21) considered “long-wave cycles” to be those which lasted
5–10 years generally. Kondratieff (“Die langen Wellen der Konjunktur” in
Archiv für Sozialwissenschaft 56, pp. 573ff.) tried to prove, unsuccessfully
in my judgment, that, in addition to the 7–11 year cycles of business con-
ditions which he called medium cycles, there were also regular cyclical
waves averaging 50 years in length.

118 — The Causes of the Economic Crisis

[The German term, “Sanierungskrise,” means literally “restoration cri-

sis,” i.e., the crisis which comes at the shift to more “healthy” monetary
relationships. In English this crisis is called the “stabilization crisis.”—Ed.]

“stabilization crisis”

appears. The cause and appearance of this

crisis correspond precisely to those of the crisis which comes at
the close of a period of circulation credit expansion. One must
clearly distinguish this crisis [i.e., when increases in the quantity
of money are simply halted] from the consequences which must
result when the cessation of inflation is followed by deflation.

There is no regularity as to the recurrence of paper money

inflations. They generally originate in a certain political attitude,
not from events within the economy itself. One can only say, with
certainty, that after a country has pursued an inflationist policy to
its end or, at least, to substantial lengths, it cannot soon use this
means again successfully to serve its financial interests. The peo-
ple, as a result of their experience, will have become distrustful
and would resist any attempt at a renewal of inflation.

Even at the very beginning of a new inflation, people would

reject the notes or accept them only at a far greater discount than
the actual increased quantity would otherwise warrant. As a rule,
such an unusually high discount is characteristic of the final
phases of an inflation. Thus an early attempt to return to a policy
of paper money inflation must either fail entirely or come very
quickly to a catastrophic conclusion. One can assume—and mon-
etary history confirms this, or at least does not contradict
it—that a new generation must grow up before consideration can
again be given to bolstering the government’s finances with the
printing press.

Many states have never pursued a policy of paper money infla-

tion. Many have resorted to it only once in their history. Even the
states traditionally known for their printing press money have
not repeated the experiment often. Austria waited almost a gen-
eration after the banknote inflation of the Napoleonic era before
embarking on an inflation policy again. Even then, the inflation
was in more modest proportions than at the beginning of the

Monetary Stabilization and Cyclical Policy — 119

Lord Samuel Jones Loyd Overstone, “Reflections Suggested by a

Perusal of Mr. J. Horsley Palmer’s Pamphlet on the Causes and
Consequences of the Pressure on the Money Market,” 1837. (Reprinted in
Tracts and Other Publications on Metallic and Paper Currency [London,
1857], p. 31.)

nineteenth century. Almost a half century passed between the
end of her second and the beginning of her third and most recent
period of inflation. It is by no means possible to speak of cyclical
reappearances of paper money inflations.

3. T

YCLICAL

ROCESS OF

REDIT

XPANSIONS

Regularity can be detected only with respect to the phenom-

ena originating out of circulation credit. Crises have reappeared
every few years since banks issuing fiduciary media began to play
an important role in the economic life of people. Stagnation fol-
lowed crisis, and following these came the boom again. More
than ninety years ago Lord Overstone described the sequence in
a remarkably graphic manner:

We find it [the “state of trade”] subject to various condi-
tions which are periodically returning; it revolves
apparently in an established cycle. First we find it in a
state of quiescence, —next improvement, —growing
confidence, —prosperity, —excitement, —overtrading,
—convulsion, —pressure, —stagnation, —distress, —
ending again in quiescence.

This description, unrivaled for its brevity and clarity, must be
kept in mind to realize how wrong it is to give later economists
credit for transforming the problem of the crisis into the problem
of general business conditions.

Attempts have been made, with little success, to supplement

the observation that business cycles recur by attributing a defi-
nite time period to the sequence of events. Theories which
sought the source of economic change in recurring cosmic events
have, as might be expected, leaned in this direction. A study of
economic history fails to support such assumptions. It shows

120 — The Causes of the Economic Crisis

recurring ups and downs in business conditions, but not ups and
downs of equal length.

The problem to be solved is the recurrence of fluctuations in

business activity. The Circulation Credit Theory shows us, in
rough outline, the typical course of a cycle. However, so far as we
have as yet analyzed the theory, it still does not explain why the
cycle always recurs.

According to the Circulation Credit Theory, it is clear that the

direct stimulus which provokes the fluctuations is to be sought in
the conduct of the banks. Insofar as they start to reduce the
“money rate of interest” below the “natural rate of interest,” they
expand circulation credit, and thus divert the course of events
away from the path of normal development. They bring about
changes in relationships which must necessarily lead to boom
and crisis. Thus, the problem consists of asking what leads the
banks again and again to renew attempts to expand the volume of
circulation credit.

Many authors believe that the instigation of the banks’ behav-

ior comes from outside, that certain events induce them to pump
more fiduciary media into circulation and that they would
behave differently if these circumstances failed to appear. I was
also inclined to this view in the first edition of my book on mon-
etary theory.

I could not understand why the banks didn’t learn

from experience. I thought they would certainly persist in a pol-
icy of caution and restraint, if they were not led by outside
circumstances to abandon it. Only later did I become convinced
that it was useless to look to an outside stimulus for the change
in the conduct of the banks. Only later did I also become con-
vinced that fluctuations in general business conditions were

See Theorie des Geldes und der Umlaufsmittel (1912), pp. 433ff. I had

been deeply impressed by the fact that Lord Overstone was also apparently
inclined to this interpretation. See his “Reflections,” pp. 32ff. [NOTE:
These paragraphs were deleted from the 2nd German edition (1924) from
which was made the H.E. Batson English translation, The Theory of Money
and Credit, published 1934, 1953, and 1971.—Ed.]

Monetary Stabilization and Cyclical Policy — 121

completely dependent on the relationship of the quantity of fidu-
ciary media in circulation to demand.

Each new issue of fiduciary media has the consequences

described above. First of all, it depresses the loan rate and then it
reduces the monetary unit’s purchasing power. Every subsequent
issue brings the same result. The establishment of new banks of
issue and their step-by-step expansion of circulation credit pro-
vides the means for a business boom and, as a result, leads to the
crisis with its accompanying decline. We can readily understand
that the banks issuing fiduciary media, in order to improve their
chances for profit, may be ready to expand the volume of credit
granted and the number of notes issued. What calls for special
explanation is why attempts are made again and again to
improve general economic conditions by the expansion of circu-
lation credit in spite of the spectacular failure of such efforts in
the past.

The answer must run as follows: According to the prevailing

ideology of businessman and economist-politician, the reduction
of the interest rate is considered an essential goal of economic
policy. Moreover, the expansion of circulation credit is assumed
to be the appropriate means to achieve this goal.

4. T

ANIA FOR

OWER

NTEREST

ATES

The naïve inflationist theory of the seventeenth and eigh-

teenth centuries could not stand up in the long run against the
criticism of economics. In the nineteenth century, that doctrine
was held only by obscure authors who had no connection with
scientific inquiry or practical economic policy. For purely politi-
cal reasons, the school of empirical and historical “Realism” did
not pay attention to problems of economic theory. It was due
only to this neglect of theory that the naïve theory of inflation
was once more able to gain prestige temporarily during the
World War, especially in Germany.

The doctrine of inflationism by way of fiduciary media was

more durable. Adam Smith had battered it severely, as had others

122 — The Causes of the Economic Crisis

William Douglass (1691–1752), a renowned physician, came to

America in 1716. His “A Discourse Concerning the Currencies of the
British Plantations in America” (1739) first appeared anonymously.

even before him, especially the American William Douglass.

Many, notably in the Currency School, had followed. But then
came a reversal. The Banking School confused the situation. Its
founders failed to see the error in their doctrine. They failed to
see that the expansion of circulation credit lowered the interest
rate. They even argued that it was impossible to expand credit
beyond the “needs of business.” So there are seeds in the Banking
Theory which need only to be developed to reach the conclusion
that the interest rate can be reduced by the conduct of the banks.
At the very least, it must be admitted that those who dealt with
those problems did not sufficiently understand the reasons for
opposing credit expansion to be able to overcome the public
clamor for the banks to provide “cheap money.”

In discussions of the rate of interest, the economic press

adopted the questionable jargon of the business world, speaking
of a “scarcity” or an “abundance” of money and calling the short
term loan market the “money market.” Banks issuing fiduciary
media, warned by experience to be cautious, practiced discre-
tion and hesitated to indulge the universal desire of the press,
political parties, parliaments, governments, entrepreneurs,
landowners and workers for cheaper credit. Their reluctance to
expand credit was falsely attributed to reprehensible motives.
Even newspapers, that knew better, and politicians, who should
have known better, never tired of asserting that the banks of
issue could certainly discount larger sums more cheaply if they
were not trying to hold the interest rate as high as possible out of
concern for their own profitability and the interests of their con-
trolling capitalists.

Almost without exception, the great European banks of issue

on the continent were established with the expectation that the
loan rate could be reduced by issuing fiduciary media. Under the
influence of the Currency School doctrine, at first in England and

Monetary Stabilization and Cyclical Policy — 123

then in other countries where old laws did not restrict the issue
of notes, arrangements were made to limit the expansion of cir-
culation credit, at least of that part granted through the issue of
uncovered banknotes. Still, the Currency Theory lost out as a
result of criticism by Tooke (1774–1858) and his followers.
Although it was considered risky to abolish the laws which
restricted the issue of notes, no harm was seen in circumventing
them. Actually, the letter of the banking laws provided for a con-
centration of the nation’s supply of precious metals in the vaults
of banks of issue. This permitted an increase in the issue of fidu-
ciary media and played an important role in the expansion of the
gold exchange standard.

Before the war [1914], there was no hesitation in Germany in

openly advocating withdrawal of gold from trade so that the
Reichsbank might issue sixty marks in notes for every twenty
marks in gold added to its stock. Propaganda was also made for
expanding the use of payments by check with the explanation
that this was a means to lower the interest rate substantially.

The situation was similar elsewhere, although perhaps more cau-
tiously expressed.

Every single fluctuation in general business conditions—the

upswing to the peak of the wave and the decline into the trough
which follows—is prompted by the attempt of the banks of issue
to reduce the loan rate and thus expand the volume of circulation
credit through an increase in the supply of fiduciary media (i.e.,
banknotes and checking accounts not fully backed by money).
The fact that these efforts are resumed again and again in spite of
their widely deplored consequences, causing one business cycle
after another, can be attributed to the predominance of an ideol-
ogy—an ideology which regards rising commodity prices and
especially a low rate of interest as goals of economic policy. The
theory is that even this second goal may be attained by the expan-
sion of fiduciary media. Both crisis and depression are lamented.
Yet, because the causal connection between the behavior of the

[See the examples cited in The Theory of Money and Credit (pp. 387ff.; 1980,

pp. 426ff.).—Ed.]

124 — The Causes of the Economic Crisis

banks of issue and the evils complained about is not correctly
interpreted, a policy with respect to interest is advocated which, in
the last analysis, must necessarily always lead to crisis and depres-
sion.

5. F

REE

ANKING

Every deviation from the prices, wage rates and interest rates

which would prevail on the unhampered market must lead to dis-
turbances of the economic “equilibrium.” This disturbance,
brought about by attempts to depress the interest rate artificially,
is precisely the cause of the crisis.

The ultimate cause, therefore, of the phenomenon of wave

after wave of economic ups and downs is ideological in character.
The cycles will not disappear so long as people believe that the
rate of interest may be reduced, not through the accumulation of
capital, but by banking policy.

Even if governments had never concerned themselves with the

issue of fiduciary media, there would still be banks of issue and
fiduciary media in the form of notes as well as checking accounts.
There would then be no legal limitation on the issue of fiduciary
media. Free banking would prevail. However, banks would have
to be especially cautious because of the sensitivity to loss of rep-
utation of their fiduciary media, which no one would be forced to
accept. In the course of time, the inhabitants of capitalistic coun-
tries would learn to differentiate between good and bad banks.
Those living in “undeveloped” countries would distrust all banks.
No government would exert pressure on the banks to discount
on easier terms than the banks themselves could justify.
However, the managers of solvent and highly respected banks,
the only banks whose fiduciary media would enjoy the general
confidence essential for money-substitute quality, would have
learned from past experiences. Even if they scarcely detected the
deeper correlations, they would nevertheless know how far they
might go without precipitating the danger of a breakdown.

The cautious policy of restraint on the part of respected and

well-established banks would compel the more irresponsible

managers of other banks to follow suit, however much they
might want to discount more generously. For the expansion of
circulation credit can never be the act of one individual bank
alone, nor even of a group of individual banks. It always requires
that the fiduciary media be generally accepted as a money substi-
tute. If several banks of issue, each enjoying equal rights, existed
side by side, and if some of them sought to expand the volume of
circulation credit while the others did not alter their conduct,
then at every bank clearing, demand balances would regularly
appear in favor of the conservative enterprises. As a result of the
presentation of notes for redemption and withdrawal of their
cash balances, the expanding banks would very quickly be com-
pelled once more to limit the scale of their emissions.

In the course of the development of a banking system with fidu-

ciary media, crises could not have been avoided. However, as soon
as bankers recognized the dangers of expanding circulation credit,
they would have done their utmost, in their own interests, to avoid
the crisis. They would then have taken the only course leading to
this goal: extreme restraint in the issue of fiduciary media.

6. G

OVERNMENT

NTERVENTION IN

ANKING

The fact that the development of fiduciary media banking

took a different turn may be attributed entirely to the circum-
stance that the issue of banknotes (which for a long time were the
only form of fiduciary media and are today [1928] still the more
important, even in the United States and England) became a pub-
lic concern. The private bankers and joint-stock banks were
supplanted by the politically privileged banks of issue because
the governments favored the expansion of circulation credit for
reasons of fiscal and credit policy. The privileged institutions
could proceed unhesitatingly in the granting of credit, not only
because they usually held a monopoly in the issue of notes, but
also because they could rely on the government’s help in an
emergency. The private banker would go bankrupt, if he ven-
tured too far in the issue of credit. The privileged bank received
permission to suspend payments and its notes were made legal
tender at face value.

Monetary Stabilization and Cyclical Policy — 125

If the knowledge derived from the Currency Theory had led to

the conclusion that fiduciary media should be deprived of all spe-
cial privileges and placed, like other claims, under general law in
every respect and without exception, this would probably have
contributed more toward eliminating the threat of crises than
was actually accomplished by establishing rigid proportions for
the issue of fiduciary media in the form of notes and restricting
the freedom of banks to issue fiduciary media in the form of
checking accounts. The principle of free banking was limited to
the field of checking accounts. In fact, it could not function here
to bring about restraint on the part of banks and bankers. Public
opinion decreed that government should be guided by a different
policy—a policy of coming to the assistance of the central banks
of issue in times of crises. To permit the Bank of England to lend
a helping hand to banks which had gotten into trouble by
expanding circulation credit, the Peel Act was suspended in 1847,
1857 and 1866. Such assistance, in one form or another, has been
offered time and again everywhere.

In the United States, national banking legislation made it tech-

nically difficult, if not entirely impossible, to grant such aid. The
system was considered especially unsatisfactory, precisely
because of the legal obstacles it placed in the path of helping
grantors of credit who became insolvent and of supporting the
value of circulation credit they had granted. Among the reasons
leading to the significant revision of the American banking system
[i.e., the Federal Reserve Act of 1913], the most important was the
belief that provisions must be made for times of crises. In other
words, just as the emergency institution of Clearing House
Certificates was able to save expanding banks, so should technical
expedients be used to prevent the breakdown of the banks and
bankers whose conduct had led to the crisis. It was usually consid-
ered especially important to shield the banks which expanded
circulation credit from the consequences of their conduct. One of
the chief tasks of the central banks of issue was to jump into this
breach. It was also considered the duty of those other banks who,
thanks to foresight, had succeeded in preserving their solvency,
even in the general crisis, to help fellow banks in difficulty.

126 — The Causes of the Economic Crisis

Monetary Stabilization and Cyclical Policy — 127

7. I

NTERVENTION

EMEDY

It may well be asked whether the damage inflicted by misguid-

ing entrepreneurial activity by artificially lowering the loan rate
would be greater if the crisis were permitted to run its course.
Certainly many saved by the intervention would be sacrificed in
the panic, but if such enterprises were permitted to fail, others
would prosper. Still the total loss brought about by the “boom”
(which the crisis did not produce, but only made evident) is
largely due to the fact that factors of production were expended
for fixed investments which, in the light of economic conditions,
were not the most urgent. As a result, these factors of production
are now lacking for more urgent uses. If intervention prevents
the transfer of goods from the hands of imprudent entrepreneurs
to those who would now take over because they have evidenced
better foresight, this imbalance becomes neither less significant
nor less perceptible.

In any event, the practice of intervening for the benefit of

banks, rendered insolvent by the crisis, and of the customers of
these banks, has resulted in suspending the market forces which
could serve to prevent a return of the expansion, in the form of a
new boom, and the crisis which inevitably follows. If the banks
emerge from the crisis unscathed, or only slightly weakened,
what remains to restrain them from embarking once more on an
attempt to reduce artificially the interest rate on loans and
expand circulation credit? If the crisis were ruthlessly permitted
to run its course, bringing about the destruction of enterprises
which were unable to meet their obligations, then all entrepre-
neurs—not only banks but also other businessmen—would
exhibit more caution in granting and using credit in the future.
Instead, public opinion approves of giving assistance in the crisis.
Then, no sooner is the worst over, than the banks are spurred on
to a new expansion of circulation credit.

To the businessman, it appears most natural and understand-

able that the banks should satisfy his demand for credit by the
creation of fiduciary media. The banks, he believes, should have
the task and the duty to “stand by” business and trade. There is

128 — The Causes of the Economic Crisis

no dispute but that the expansion of circulation credit furthers
the accumulation of capital within the narrow limits of the
“forced savings” it brings about and to that extent permits an
increase in productivity. Still it can be argued that, given the sit-
uation, each step in this direction steers business activity, in the
manner described above, on a “wrong” course. The discrepancy
between what the entrepreneurs do and what the unhampered
market would have prescribed becomes evident in the crisis. The
fact that each crisis, with its unpleasant consequences, is fol-
lowed once more by a new “boom,” which must eventually
expend itself as another crisis, is due only to the circumstances
that the ideology which dominates all influential groups—politi-
cal economists, politicians, statesmen, the press and the business
world—not only sanctions, but also demands, the expansion of
circulation credit.

IV.

RISIS

OLICY OF THE

URRENCY

CHOOL

1. T

NADEQUACY OF THE

URRENCY

CHOOL

Every advance toward explaining the problem of business fluc-

tuations to date is due to the Currency School. We are also
indebted to this School alone for the ideas responsible for policies
aimed at eliminating business fluctuations. The fatal error of the
Currency School consisted in the fact that it failed to recognize
the similarity between banknotes and bank demand deposits as
money substitutes and, thus, as money certificates and fiduciary
media. In their eyes, only the banknote was a money substitute.
In their view, therefore, the circulation of pure metallic money
could only be adulterated by the introduction of a banknote not
covered by money.

Monetary Stabilization and Cyclical Policy — 129

Consequently, they thought that the only thing that needed to

be done to prevent the periodic return of crises was to set a rigid
limit for the issue of banknotes not backed by metal. The issue of
fiduciary media in the form of demand deposits not covered by
metal was left free.

Since nothing stood in the way of granting

circulation credit through bank deposits, the policy of expanding
circulation credit could be continued even in England. When
technical difficulties limited further bank loans and precipitated a
crisis, it became customary to come to the assistance of the banks
and their customers with special issues of notes. The practice of
restricting the notes in circulation not covered by metal, by limit-
ing the ratio of such notes to metal, systematized this procedure.
Banks could expand the volume of credit with ease if they could
count on the support of the bank of issue in an emergency.

If all further expansion of fiduciary media had been forbidden

in any form, that is, if the banks had been obliged to hold full
reserves for both the additional notes issued and increases in cus-
tomers’ demand deposits subject to check or similar claim—or at
least had not been permitted to increase the quantity of fiduciary
media beyond a strictly limited ratio—prices would have
declined sharply, especially at times when the increased demand
for money surpassed the increase in its quantity. The economy
would then not only have lacked the drive contributed by any
“forced savings,” it would also have temporarily suffered from the
consequences of a rise in the monetary unit’s purchasing power
[i.e., falling prices]. Capital accumulation would then have been
slowed down, although certainly not stopped. In any case, the
economy surely would not then have experienced periods of
stormy upswings followed by dramatic reversals of the upswings
into crises and declines.

There is little sense in discussing whether it would have been

better to restrict, in this way, the issue of fiduciary media by the

Even the countries that have followed different procedures in this

respect have, for all practical purposes, placed no obstacle in the way of the
development of fiduciary media in the form of bank deposits.

130 — The Causes of the Economic Crisis

[According to Professor Mises, the “three European empires” were

Austria-Hungary, Germany and Russia. This designation probably comes
from the “Three Emperors’ League” (1872), an informal alliance among
these governments. Its effectiveness was declining by 1890, and World War
I dealt it a final blow.—Ed.]

banks than it was to pursue the policy actually followed. The
alternatives are not merely restriction or freedom in the issue of
fiduciary media. The alternatives are, or at least were, privilege in
the granting of fiduciary media or true free banking.

The possibility of free banking has scarcely even been sug-

gested. Intervention cast its first shadow over the capitalistic
system when banking policy came to the forefront of economic
and political discussion. To be sure, some authors, who defended
free banking, appeared on the scene. However, their voices were
overpowered. The desired goal was to protect the noteholders
against the banks. It was forgotten that those hurt by the danger-
ous suspension of payments by the banks of issue are always the
very ones the law was intended to help. No matter how severe the
consequences one may anticipate from a breakdown of the banks
under a system of absolutely free banking, one would have to
admit that they could never even remotely approach the severity
of those brought about by the war and postwar banking policies
of the three European empires.

2. “B

OOMS

” F

AVORED

In the last two generations, hardly anyone, who has given this

matter some thought, can fail to know that a crisis follows a
boom. Nevertheless, it would have been impossible for even the
sharpest and cleverest banker to suppress in time the expansion
of circulation credit. Public opinion stood in the way. The fact
that business conditions fluctuated violently was generally
assumed to be inherent in the capitalistic system. Under the
influence of the Banking Theory, it was thought that the banks
merely went along with the upswing and that their conduct had
nothing to do with bringing it about or advancing it. If, after a

Monetary Stabilization and Cyclical Policy — 131

long period of stagnation, the banks again began to respond to
the general demand for easier credit, public opinion was always
delighted by the signs of the start of a boom.

In view of the prevailing ideology, it would have been com-

pletely unthinkable for the banks to apply the brakes at the start
of such a boom. If business conditions continued to improve,
then, in conformity with the principles of Lord Overstone,
prophecies of a reaction certainly increased in number. However,
even those who gave this warning usually did not call for a rigor-
ous halt to all further expansion of circulation credit. They asked
only for moderation and for restricting newly granted credits to
“non-speculative” businesses.

Then finally, if the banks changed their policy and the crisis

came, it was always easy to find culprits. But there was no desire
to locate the real offender—the false theoretical doctrine. So no
changes were made in traditional procedures. Economic waves
continued to follow one another.

The managers of the banks of issue have carried out their pol-

icy without reflecting very much on its basis. If the expansion of
circulation credit began to alarm them, they proceeded, not
always very skillfully, to raise the discount rate. Thus, they
exposed themselves to public censure for having initiated the cri-
sis by their behavior. It is clear that the crisis must come sooner
or later. It is also clear that the crisis must always be caused, pri-
marily and directly, by the change in the conduct of the banks. If
we speak of error on the part of the banks, however, we must
point to the wrong they do in encouraging the upswing. The fault
lies, not with the policy of raising the interest rate, but only with
the fact that it was raised too late.

132 — The Causes of the Economic Crisis

ODERN

YCLICAL

OLICY

1. P

-W

ORLD

I P

OLICY

The cyclical policy recommended today, in most of the litera-

ture dealing with the problem of business fluctuations and
toward which considerable strides have already been made in the
United States, rests entirely on the reasoning of the Circulation
Credit Theory.

The aim of much of this literature is to make

this theory useful in practice by studying business conditions
with precise statistical methods.

There is no need to explain further that there is only one busi-

ness cycle theory—the Circulation Credit Theory. All other
attempts to cope with the problem have failed to withstand criti-
cism. Every crisis policy and every cyclical policy has been
derived from this theory. Its ideas have formed the basis of those
cyclical and crisis policies pursued in the decades preceding the
war. Thus, the Banking Theory, then recognized in literature as
the only correct explanation, as well as all those interpretations
which related the problem to the theory of direct exchange, were
already disregarded. It may have still been popular to speak of the
elasticity of notes in circulation as depending on the discounting
of commodity bills of exchange. However, in the world of the
bank managers, who made cyclical policy, other views prevailed.

To this extent, therefore, one cannot say that the theory

behind today’s cyclical policy is new. The Circulation Credit
Theory has, to be sure, come a long way from the old Currency
Theory. The studies which Walras, Wicksell and I have devoted

[Mises undoubtedly refers here to the way the Federal Reserve System

reacted to the post World War I boom, when it brought an end to credit
expansion by raising the discount rate, thus precipitating the 1920–1921
correction period, popularly called a “recession.”—Ed.]

Monetary Stabilization and Cyclical Policy — 133

[Frédéric Bastiat (1801–1850) replied to an open letter addressed to

him by an editor of Voix du Peuple (October 22, 1849). Then the Socialist,
Pierre Jean Proudhon (1809–1865), answered. Proudhon, an advocate of
unlimited monetary expansion by reduction of the interest rate to zero, and
Bastiat, who favored moderate credit expansion and only a limited reduc-
tion of interest rates, carried on a lengthy exchange for several months,
until March 7, 1850. (Oeuvres Completes de Frédéric Bastiat, 4th ed., vol. 5
[Paris, 1878], pp. 93–336.) —Ed.]

to the problem have conceived of it as a more general phenome-
non. These studies have related it to the whole economic process.
They have sought to deal with it especially as a problem of inter-
est rate formulation and of “equilibrium” on the loan market. To
recognize the extent of the progress made, compare, for instance,
the famous controversy over free credit between Bastiat and
Proudhon.

Or compare the usual criticism of the Quantity

Theory in prewar German literature with recent discussions on
the subject. However, no matter how significant this progress
may be considered for the development of our understanding, we
should not forget that the Currency Theory had already offered
policy making every assistance in this regard that a theory can.

It is certainly not to be disputed that substantial progress was

made when the problem was considered, not only from the point
of view of fiduciary media, but from that of the entire problem of
the purchasing power of money. The Currency School paid
attention to price changes only insofar as they were produced by
an increase or decrease of circulation credit—but they consid-
ered only the circulation credit granted by the issue of notes.
Thus, the Currency School was a long way from striving for sta-
bilization of the purchasing power of the monetary unit.

2. P

OST

-W

ORLD

I P

OLICIES

Today these two problems, the issuance of fiduciary media

and the purchasing power of the monetary unit, are seen as being
closely linked to the Circulation Credit Theory. One of the ten-
dencies of modern cyclical policy is that these two problems are
treated as one. Thus, one aim of cyclical policy is no more nor

134 — The Causes of the Economic Crisis

less than the stabilization of the purchasing power of money. For
a discussion of this see Part I of this study.

Like the Currency School, the other aim is not to stabilize pur-

chasing power but only to avoid the crisis. However, a still further
goal is contemplated—similar to that sought by the Peel Act and
by prewar cyclical policy. It is proposed to counteract a boom,
whether caused by an expansion of fiduciary media or by a mon-
etary inflation (for example, an increase in the production of
gold). Then, again, depression is to be avoided when there is
restriction irrespective of whether it starts with a contraction in
the quantity of money or of fiduciary media. The aim is not to
keep prices stable, but to prevent the free market interest rate
from being reduced temporarily by the banks of issue or by mon-
etary inflation.

In order to explain the essence of this new policy, we shall now

explore two specific cases in more detail:

1. The production of gold increases and prices rise. A price

premium appears in the interest rate that would limit the demand
for loans to the supply of lendable funds available. The banks,
however, have no reason to raise their lending rate. As a matter of
fact, they become more willing to discount at a lower rate as the
relationship between their obligations and their stock of gold has
been improved. It has certainly not deteriorated. The actual loan
rate they are asking lags behind the interest rate that would pre-
vail on a free market, thus providing the initiative for a boom. In
this instance, prewar crisis policy would not have intervened since
it considered only the ratio of the bank’s cover which had not
deteriorated. As prices and wages rise [resulting in an increased
demand for business loans], modern theory maintains that the
interest rates should rise and circulation credit be restricted.

2. The inducement to the boom has been given by the banks

in response, let us say, to the general pressure to make credit
cheaper in order to combat depression, without any change in the
quantity of money in the narrower sense. Since the cover ratio
deteriorates as a result, even the older crisis policy would have
called for increasing the interest rate as a brake.

Monetary Stabilization and Cyclical Policy — 135

This Harvard barometer was developed at the University by the

Committee on Economic Research from three statistical series which are
presumed to reveal (1) the extent of stock speculation, (2) the condition of
industry and trade and (3) the supply of funds.

Only in the first of these two instances does a fundamental dif-

ference exist between old and new policies.

3. E

MPIRICAL

TUDIES

Many now engaged in cyclical research maintain that the spe-

cial superiority of current crisis policy in America rests on the
use of more precise statistical methods than those previously
available. Presumably, means for eliminating seasonal fluctua-
tions and the secular general trend have been developed from
statistical series and curves. Obviously, it is only with such
manipulations that the findings of a market study may become a
study of the business cycle. However, even if one should agree
with the American investigators in their evaluation of the success
of this effort, the question remains as to the usefulness of index
numbers. Nothing more can be added to what has been said
above on the subject, in Part I of this study.

The development of the Three Market Barometer

is consid-

ered the most important accomplishment of the Harvard
investigations. Since it is not possible to determine Wicksell’s
natural rate of interest or the “ideal” price premium, we are
advised to compare the change in the interest rate with the move-
ment of prices and other data indicative of business conditions,
such as production figures, the number of unemployed, etc. This
has been done for decades. One need only glance at reports in the
daily papers, economic weeklies, monthlies and annuals of the
last two generations to discover that the many claims, made so
proudly today, of being the first to recognize the significance of
such data for understanding the course of business conditions,
are unwarranted. The Harvard institute, however, has performed
a service in that it has sought to establish an empirical regularity
in the timing of the movements in the three curves.

136 — The Causes of the Economic Crisis

There is no need to share the exuberant expectations for the

practical usefulness of the Harvard barometer which has pre-
vailed in the American business world for some time. It can
readily be admitted that this barometer has scarcely contributed
anything toward increasing and deepening our knowledge of
cyclical movements. Nevertheless, the significance of the
Harvard barometer for the investigation of business conditions
may still be highly valued, for it does provide statistical substan-
tiation of the Circulation Credit Theory. Twenty years ago, it
would not have been thought possible to arrange and manipulate
statistical material so as to make it useful for the study of business
conditions. Here real success has crowned the ingenious work
done by economists and statisticians together.

Upon examining the curves developed by institutes using the

Harvard method, it becomes apparent that the movement of the
money market curve (C Curve) in relation to the stock market
curve (A Curve) and the commodity market curve (B Curve) cor-
responds exactly to what the Circulation Credit Theory asserts.
The fact that the movements of A Curve generally anticipate those
of B Curve is explained by the greater sensitivity of stock, as
opposed to commodity, speculation. The stock market reacts more
promptly than does the commodity market. It sees more and it
sees farther. It is quicker to draw coming events (in this case, the
changes in the interest rate) into the sphere of its conjectures.

4. A

RBITRARY

OLITICAL

ECISIONS

However, the crucial question still remains: What does the

Three Market Barometer offer the man who is actually making
bank policy? Are modern methods of studying business condi-
tions better suited than the former, to be sure less thorough, ones
for laying the groundwork for decisions on a discount policy
aimed at reducing as much as possible the ups and downs of busi-
ness? Even prewar [World War I] banking policy had this for its
goal. There is no doubt but that government agencies responsible
for financial policy, directors of the central banks of issue and
also of the large private banks and banking houses, were frankly

Monetary Stabilization and Cyclical Policy — 137

and sincerely interested in attaining this goal. Their efforts in this
direction—only when the boom was already in full swing to be
sure—were supported at least by a segment of public opinion and
of the press. They knew well enough what was needed to accom-
plish the desired effect. They knew that nothing but a timely and
sufficiently far-reaching increase in the loan rate could counter-
act what was usually referred to as “excessive speculation.”

They failed to recognize the fundamental problem. They did

not understand that every increase in the amount of circulation
credit (whether brought about by the issue of banknotes or
expanding bank deposits) causes a surge in business and thus
starts the cycle which leads once more, over and beyond the cri-
sis, to the decline in business activity. In short, they embraced the
very ideology responsible for generating business fluctuations.
However, this fact did not prevent them, once the cyclical
upswing became obvious, from thinking about its unavoidable
outcome. They did not know that the upswing had been gener-
ated by the conduct of the banks. If they had, they might well have
seen it only as a blessing of banking policy, for to them the most
important task of economic policy was to overcome the depres-
sion, at least so long as the depression lasted. Still they knew that
a progressing upswing must lead to crisis and then to stagnation.

As a result, the trade boom evoked misgivings at once. The

immediate problem became simply how to counteract the
onward course of the “unhealthy” development. There was no
question of “whether,” but only of “how.” Since the method—
increasing the interest rate—was already settled, the question of
“how” was only a matter of timing and degree: When and how
much should the interest rate be raised?

The critical point was that this question could not be answered

precisely, on the basis of undisputed data. As a result, the decision
must always be left to discretionary judgment. Now, the more
firmly convinced those responsible were that their interference, by
raising the interest rate, would put an end to the prosperity of the
boom, the more cautiously they must act. Might not those voices
be correct which maintained that the upswing was not “artificially”
produced, that there wasn’t any “overspeculation” at all, that the

138 — The Causes of the Economic Crisis

boom was only the natural outgrowth of technical progress, the
development of means of communication, the discovery of new
supplies of raw materials, the opening up of new markets? Should
this delightful and happy state of affairs be rudely interrupted?
Should the government act in such a way that the economic
improvement, for which it took credit, gives way to crisis?

The hesitation of officials to intervene is sufficient to explain

the situation. To be sure, they had the best of intentions for stop-
ping in time. Even so, the steps they took were usually “too little
and too late.” There was always a time lag before the interest rate
reached the point at which prices must start down again. In the
interim, capital had become frozen in investments for which it
would not have been used if the interest rate on money had not
been held below its “natural rate.”

This drawback to cyclical policy is not changed in any respect

if it is carried out in accordance with the business barometer. No
one who has carefully studied the conclusions, drawn from obser-
vations of business conditions made by institutions working with
modern methods, will dare to contend that these results may be
used to establish, incontrovertibly, when and how much to raise
the interest rate in order to end the boom in time before it has led
to capital malinvestment. The accomplishment of economic jour-
nalism in reporting regularly on business conditions during the
last two generations should not be underrated. Nor should the
contribution of contemporary business cycle research institutes,
working with substantial means, be overrated. Despite all the
improvements which the preparation of statistics and graphic
interpretations have undergone, their use in the determination of
interest rate policy still leaves a wide margin for judgment.

5. S

OUND

HEORY

SSENTIAL

Moreover, it should not be forgotten that it is impossible to

answer in a straightforward manner not only how seasonal vari-
ations and growth factors are to be eliminated, but also how to
decide unequivocably from what data and by what method the
curves of each of the Three Markets should be constructed.

Arguments which cannot be easily refuted may be raised on
every point with respect to the business barometer. Also, no mat-
ter how much the business barometer may help us to survey the
many heterogeneous operations of the market and of production,
they certainly do not offer a solid basis for weighing contingen-
cies. Business barometers are not even in a position to furnish
clear and certain answers to the questions concerning cyclical
policy which are crucial for their operation. Thus, the great
expectations generally associated with recent cyclical policy
today are not justified.

For the future of cyclical policy more profound theoretical

knowledge concerning the nature of changes in business condi-
tions would inevitably be of incomparably greater value than any
conceivable manipulation of statistical methods. Some business
cycle research institutes are imbued with the erroneous idea that
they are conducting impartial factual research, free of any preju-
dice due to theoretical considerations. In fact, all their work rests
on the groundwork of the Circulation Credit Theory. In spite of
the reluctance which exists today against logical reasoning in
economics and against thinking problems and theories through
to their ultimate conclusions, a great deal would be gained if it
were decided to base cyclical policy deliberately on this theory.
Then, one would know that every expansion of circulation credit
must be counteracted in order to even out the waves of the busi-
ness cycle. Then, a force operating on one side to reduce the
purchasing power of money would be offset from the other side.
The difficulties, due to the impossibility of finding any method
for measuring changes in purchasing power, cannot be over-
come. It is impossible to realize the ideal of either a monetary
unit of unchanging value or economic stability. However, once it
is resolved to forgo the artificial stimulation of business activity
by means of banking policy, fluctuations in business conditions
will surely be substantially reduced. To be sure this will mean giv-
ing up many a well-loved slogan, for example, “easy money” to
encourage credit transactions. However, a still greater ideological
sacrifice than that is called for. The desire to reduce the interest
rate in any way must also be abandoned.

Monetary Stabilization and Cyclical Policy — 139

140 — The Causes of the Economic Crisis

It has already been pointed out that events would have turned

out very differently if there had been no deviation from the prin-
ciple of complete freedom in banking and if the issue of fiduciary
media had been in no way exempted from the rules of commer-
cial law. It may be that a final solution of the problem can be
arrived at only through the establishment of completely free
banking. However, the credit structure which has been devel-
oped by the continued effort of many generations cannot be
transformed with one blow. Future generations, who will have
recognized the basic absurdity of all interventionist attempts, will
have to deal with this question also. However, the time is not yet
ripe—not now nor in the immediate future.

VI.

ONTROL OF THE

ONEY

ARKET

1. I

NTERNATIONAL

OMPETITION OR

OOPERATION

There are many indications that public opinion has recog-

nized the significance of the role banks play in initiating the cycle
by their expansion of circulation credit. If this view should actu-
ally prevail, then the previous popularity of efforts aimed at
artificially reducing the interest rate on loans would disappear.
Banks that wanted to expand their issue of fiduciary media would
no longer be able to count on public approval or government
support. They would become more careful and more temperate.
That would smooth out the waves of the cycle and reduce the
severity of the sudden shift from rise to fall.

However, there are some indications which seem to contradict

this view of public opinion. Most important among these are the
attempts or, more precisely, the reasoning which underlies the
attempts to bring about international cooperation among the
banks of issue.

Monetary Stabilization and Cyclical Policy — 141

In speculative periods of the past, the very fact that the banks

of the various countries did not work together systematically, and
according to agreement, constituted a most effective brake. With
closely-knit international economic relations, the expansion of
circulation credit could only become universal if it were an inter-
national phenomenon. Accordingly, lacking any international
agreement, individual banks, fearing a large outflow of capital,
took care in setting their interest rates not to lag far below the
rates of the banks of other countries. Thus, in response to inter-
est rate arbitrage and any deterioration in the balance of trade,
brought about by higher prices, an exodus of loan money to other
countries would, for one thing, have impaired the ratio of the
bank’s cover, as a result of foreign claims on their gold and foreign
exchange which such conditions impose on the bank of issue.
The bank, obliged to consider its solvency, would then be forced
to restrict credit. In addition, this impairment of the ever-shifting
balance of payments would create a shortage of funds on the
money market which the banks would be powerless to combat.
The closer the economic connections among peoples become,
the less possible it is to have a national boom. The business cli-
mate becomes an international phenomenon.

However, in many countries, especially in the German Reich,

the view has frequently been expressed by friends of “cheap
money” that it is only the gold standard that forces the bank of
issue to consider interest rates abroad in determining its own
interest policy. According to this view, if the bank were free of
this shackle, it could then better satisfy the demands of the
domestic money market, to the advantage of the national econ-
omy. With this view in mind, there were in Germany advocates of
bimetallism, as well as of a gold premium policy.

In Austria,

there was resistance to formalizing legally the de facto practice of
redeeming its notes.

It is easy to see the fallacy in this doctrine that only the tie of

the monetary unit to gold keeps the banks from reducing inter-
est rates at will. Even if all ties with the gold standard were

[See above p. 41, note 26.—Ed.]

142 — The Causes of the Economic Crisis

broken, this would not have given the banks the power to lower
the interest rate, below the height of the “natural” interest rate,
with impunity. To be sure, the paper standard would have per-
mitted them to continue the expansion of circulation credit
without hesitation, because a bank of issue, relieved of the obli-
gation of redeeming its notes, need have no fear with respect to
its solvency. Still, the increase in notes would have led first to
price increases and consequently to a deterioration in the rate of
exchange. Second, the crisis would have come—later, to be sure,
but all the more severely.

If the banks of issue were to consider seriously making agree-

ments with respect to discount policy, this would eliminate one
effective check. By acting in unison, the banks could extend more
circulation credit than they do now, without any fear that the
consequences would lead to a situation which produces an exter-
nal drain of funds from the money market. To be sure, if this
concern with the situation abroad is eliminated, the banks are
still not always in a position to reduce the money rate of interest
below its “natural” rate in the long run. However, the difference
between the two interest rates can be maintained longer, so that
the inevitable result—malinvestment of capital—appears on a
larger scale. This must then intensify the unavoidable crisis and
deepen the depression.

So far, it is true, the banks of issue have made no significant

agreements on cyclical policy. Nevertheless, efforts aimed at such
agreements are certainly being proposed on every side.

2. “B

OOM

” P

ROMOTION

ROBLEMS

Another dangerous sign is that the slogan concerning the need

to “control the money market,” through the banks of issue, still
retains its prestige.

Given the situation, especially as it has developed in Europe,

only the central banks are entitled to issue notes. Under that
system, attempts to expand circulation credit universally can only
originate with the central bank of issue. Every venture on the part
of private banks, against the wish or the plan of the central bank,

Monetary Stabilization and Cyclical Policy — 143

[See above p. 68, note 11.—Ed.]

is doomed from the very beginning. Even banking techniques,
learned from the Anglo-Saxons, are of no service to private banks,
since the opportunity for granting credit, by opening bank
deposits, is insignificant in countries where the use of checks
(except for central bank clearings and the circulation of postal
checks) is confined to a narrow circle in the business world.
However, if the central bank of issue embarks upon a policy of
credit expansion and thus begins to force down the rate of inter-
est, it may be advantageous for the largest private banks to follow
suit and expand the volume of circulation credit they grant too.
Such a procedure has still a further advantage for them. It involves
them in no risk. If confidence is shaken during the crisis, they can
survive the critical stage with the aid of the bank of issue.

However, the bank of issue’s credit expansion policy certainly

offers a large number of banks a profitable field for speculation—
arbitrage in the loan rates of interest. They seek to profit from the
shifting ratio between domestic and foreign interest rates by
investing domestically obtained funds in short term funds
abroad. In this process, they are acting in opposition to the dis-
count policy of the bank of issue and hurting the alleged interests
of those groups which hope to benefit from the artificial reduc-
tion of the interest rate and from the boom it produces. The
ideology, which sees salvation in every effort to lower the interest
rate and regards expansion of circulation credit as the best
method of attaining this goal, is consistent with the policy of
branding the actions of the interest rate arbitrageur as scandalous
and disgraceful, even as a betrayal of the interests of his own peo-
ple to the advantage of foreigners. The policy of granting the
banks of issue every possible assistance in the fight against these
speculators is also consistent with this ideology. Both government
and bank of issue seek to intimidate the malefactors with threats,
to dissuade them from their plan. In the liberal

countries of

western Europe, at least in the past, little could be accomplished
by such methods. In the interventionist countries of middle and

144 — The Causes of the Economic Crisis

eastern Europe, attempts of this kind have met with greater suc-
cess.

It is easy to see what lies behind this effort of the bank of issue

to “control” the money market. The bank wants to prevent its
credit expansion policy, aimed at reducing the interest rate, from
being impeded by consideration of relatively restrictive policies
followed abroad. It seeks to promote a domestic boom without
interference from international reactions.

3. D

RIVE FOR

IGHTER

ONTROLS

According to the prevailing ideology, however, there are still

other occasions when the banks of issue should have stronger con-
trol over the money market. If the interest rate arbitrage, resulting
from the expansion of circulation credit, has led, for the time
being, only to a withdrawal of funds from the reserves of the issu-
ing bank, and that bank, disconcerted by the deterioration of the
security behind its notes, has proceeded to raise its discount rate,
there may still be, under certain conditions, no cause for the loan
rate to rise on the open money market. As yet no funds have been
withdrawn from the domestic market. The gold exports came
from the bank’s reserves, and the increase in the discount rate has
not led to a reduction in the credits granted by the bank. It takes
time for loan funds to become scarce as a result of the fact that
some commercial paper, which would otherwise have been offered
to the bank for discount, is disposed of on the open market. The
issuing bank, however, does not want to wait so long for its maneu-
ver to be effective. Alarmed at the state of its gold and foreign
exchange assets, it wants prompt relief. To accomplish this, it must
try to make money scarce on the market. It generally tries to bring
this about by appearing itself as a borrower on the market.

Another case, when control of the money market is contested,

concerns the utilization of funds made available to the market by
the generous discount policy. The dominant ideology favors
“cheap money.” It also favors high commodity prices, but not
always high stock market prices. The moderated interest rate is
intended to stimulate production and not to cause a stock mar-
ket boom. However, stock prices increase first of all. At the

Monetary Stabilization and Cyclical Policy — 145

outset, commodity prices are not caught up in the boom. There
are stock exchange booms and stock exchange profits. Yet, the
“producer” is dissatisfied. He envies the “speculator” his “easy
profit.” Those in power are not willing to accept this situation.
They believe that production is being deprived of money which
is flowing into the stock market. Besides, it is precisely in the
stock market boom that the serious threat of a crisis lies hidden.

Therefore, the aim is to withdraw money from stock exchange

loans in order to inject it into the “economy.” Trying to do this
simply by raising the interest rate offers no special attraction.
Such a rise in the interest rate is certainly unavoidable in the end.
It is only a question of whether it comes sooner or later.
Whenever the interest rate rises sufficiently, it brings an end to
the business boom. Therefore, other measures are tried to trans-
fer funds from the stock market into production, without
changing the cheap rate for loans. The bank of issue exerts pres-
sure on borrowers to influence the use made of the sums loaned
out. Or else it proceeds directly to set different terms for credit
depending on its use.

Thus we can see what it means if the central bank of issue aims

at domination of the money market. Either the expansion of cir-
culation credit is freed from the limitations which would
eventually restrict it or the boom is shifted by certain measures
along a course different from the one it would otherwise have fol-
lowed. Thus, the pressure for “control of the money market”
specifically envisions the encouragement of the boom—the
boom which must end in a crisis. If a cyclical policy is to be fol-
lowed to eliminate crises, this desire, the desire to control and
dominate the money market, must be abandoned.

If it were seriously desired to counteract price increases

resulting from an increase in the quantity of money—due to an
increase in the mining of gold, for example—by restricting circu-
lation credit, the central banks of issue would borrow more on
the market. Paying off these obligations later could hardly be
described as “controlling the money market.” For the bank of
issue, the restriction of circulation credit means the renunciation
of profits. It may even mean losses.

146 — The Causes of the Economic Crisis

Moreover, such a policy can be successful only if there is

agreement among the banks of issue. If restriction were practiced
by the central bank of one country only, it would result in rela-
tively high costs of borrowing money within that country. The
chief consequence of this would then be that gold would flow in
from abroad. Insofar as this is the goal sought by the cooperation
of the banks, it certainly cannot be considered a dangerous step
in the attempt toward a policy of evening out the waves of the
business cycle.

VII.

USINESS

ORECASTING

YCLICAL

OLICY

ND THE

USINESSMAN

1. C

ONTRIBUTIONS OF

USINESS

YCLE

ESEARCH

The popularity enjoyed by contemporary business cycle

research, the development of which is due above all to American
economic researchers, derives from exaggerated expectations as
to its usefulness in practice. With its help, it had been hoped to
mechanize banking policy and business activity. It had been
hoped that a glance at the business barometer would tell busi-
nessmen and those who determine banking policy how to act.

At present, this is certainly out of the question. It has already

been emphasized often enough that the results of business cycle
studies have only described past events and that they may be
used for predicting future developments only on the basis of
extremely inadequate principles. However—and this is not suffi-
ciently noted—these principles apply solely on the assumption
that the ideology calling for expansion of circulation credit has
not lost its standing in the field of economic and banking policy.
Once a serious start is made at directing cyclical policy toward the
elimination of crises, the power of this ideology is already dissi-
pated.

Monetary Stabilization and Cyclical Policy — 147

Nevertheless, one broad field remains for the employment of

the results of contemporary business cycle studies. They should
indicate to the makers of banking policy when the interest rate
must be raised to avoid instigating credit expansion. If the study
of business conditions were clear on this point and gave answers
admitting of only one interpretation, so that there could be only
one opinion, not only as to whether but also as to when and how
much to increase the discount rate, then the advantage of such
studies could not be rated highly enough. However, this is not the
case. Everything that the observation of business conditions con-
tributes in the form of manipulated data and material can be
interpreted in various ways.

Even before the development of business barometers, it was

already known that increases in stock market quotations and
commodity prices, a rise in profits on raw materials, a drop in
unemployment, an increase in business orders, the selling off of
inventories, and so on, signified a boom. The question is, when
should, or when must, the brakes be applied. However, no busi-
ness cycle institute answers this question straightforwardly and
without equivocation. What should be done will always depend
on an examination of the driving forces which shape business
conditions and on the objectives set for cyclical policy. Whether
the right moment for action is seized can never be decided except
on the basis of a careful observation of all market phenomena.
Moreover, it has never been possible to answer this question in
any other way. The fact that we now know how to classify and
describe the various market data more clearly than before does
not make the task essentially any easier.

A glance at the continuous reports on the economy and the

stock market in the large daily newspapers and in the economic
weeklies, which appeared from 1840 to 1910, shows that
attempts have been made for decades to draw conclusions from
events of the most recent past, on the basis of empirical rules, as
to the shape of the immediate future. If we compare the statisti-
cal groundwork used in these attempts with those now at our
disposal, then it is obvious that we have recourse to more data
today. We also understand better how to organize this material,

148 — The Causes of the Economic Crisis

Austria-Hungary, Germany, and Russia. [See above p. 130, note 45.—Ed.]

how to arrange it clearly and interpret it for graphic presentation.
However, we can by no means claim, with the modern methods
of studying business conditions, to have embarked on some new
principle.

2. D

IFFICULTIES OF

RECISE

REDICTION

No businessman may safely neglect any available source of

information. Thus no businessman can refuse to pay close atten-
tion to newspaper reports. Still diligent newspaper reading is no
guarantee of business success. If success were that easy, what
wealth would the journalists have already amassed! In the busi-
ness world, success depends on comprehending the situation
sooner than others do—and acting accordingly. What is recog-
nized as “fact” must first be evaluated correctly to make it useful
for an undertaking. Precisely this is the problem of putting the-
ory into practice.

A prediction, which makes judgments which are qualitative

only and not quantitative, is practically useless even if it is even-
tually proved right by the later course of events. There is also the
crucial question of timing. Decades ago, Herbert Spencer recog-
nized, with brilliant perception, that militarism, imperialism,
socialism and interventionism must lead to great wars, severe
wars. However, anyone who had started about 1890, to speculate
on the strength of that insight on a depreciation of the bonds of
the Three Empires

would have sustained heavy losses. Large

historical perspectives furnish no basis for stock market specula-
tions which must be reviewed daily, weekly, or monthly at least.

It is well known that every boom must one day come to an

end. The businessman’s situation, however, depends on knowing
exactly when and where the break will first appear. No economic
barometer can answer these questions. An economic barometer
only furnishes data from which conclusions may be drawn. Since
it is still possible for the central bank of issue to delay the start of
the catastrophe with its discount policy, the situation depends

Monetary Stabilization and Cyclical Policy — 149

Also, as a result of this, it became easier to distinguish crises originat-

ing from definite causes (wars and political upheavals, violent convulsions
of nature, changes in the shape of supply or demand) from cyclically-recur-
ring crises.

chiefly on making judgments as to the conduct of these authori-
ties. Obviously, all available data fail at this point.

But once public opinion is completely dominated by the view

that the crisis is imminent and businessmen act on this basis,
then it is already too late to derive business profit from this
knowledge. Or even merely to avoid losses. For then the panic
breaks out. The crisis has come.

VIII.

IMS AND

ETHOD OF

YCLICAL

OLICY

1. R

EVISED

URRENCY

CHOOL

HEORY

Without doubt, expanding the sphere of scientific investiga-

tion from the narrow problem of the crisis into the broader
problem of the cycle represents progress.

However, it was cer-

tainly not equally advantageous for political policies. Their scope
was broadened. They began to aspire to more than was feasible.

The economy could be organized so as to eliminate cyclical

changes only if (1) there were something more than muddled
thinking behind the concept that changes in the value of the
monetary unit can be measured, and (2) it were possible to deter-
mine in advance the extent of the effect which accompanies a
definite change in the quantity of money and fiduciary media. As
these conditions do not prevail, the goals of cyclical policy must
be more limited. However, even if only such severe shocks as
those experienced in 1857, 1873, 1900/01 and 1907, could be
avoided in the future, a great deal would have been accomplished.

150 — The Causes of the Economic Crisis

The most important prerequisite of any cyclical policy, no

matter how modest its goal may be, is to renounce every attempt
to reduce the interest rate, by means of banking policy, below the
rate which develops on the market. That means a return to the
theory of the Currency School, which sought to suppress all
future expansion of circulation credit and thus all further cre-
ation of fiduciary media. However, this does not mean a return to
the old Currency School program, the application of which was
limited to banknotes. Rather it means the introduction of a new
program based on the old Currency School theory, but expanded
in the light of the present state of knowledge to include fiduciary
media issued in the form of bank deposits.

The banks would be obliged at all times to maintain metallic

backing for all notes—except for the sum of those outstanding
which are not now covered by metal—equal to the total sum of the
notes issued and bank deposits opened. That would mean a com-
plete reorganization of central bank legislation. The banks of issue
would have to return to the principles of Peel’s Bank Act, but with
the provisions expanded to cover also bank balances subject to
check. The same stipulations with respect to reserves must also be
applied to the large national deposit institutions, especially the
postal savings.

Of course, for these secondary banks of issue, the

central bank reserves for their notes and deposits would be the
equivalent of gold reserves. In those countries where checking
accounts at private commercial banks play an important role in
trade—notably the United States and England—the same obliga-
tion must be exacted from those banks also.

By this act alone, cyclical policy would be directed in earnest

toward the elimination of crises.

[The Post Office Savings Institution, established in Austria in the 1880s

and copied in several other European countries, played a significant, if limited,
role in monetary affairs. See Mises’s comments in Human Action, pp. 445–46.
—Ed.]

2. “P

RICE

EVEL

” S

TABILIZATION

Under present circumstances, it is out of the question, in the

foreseeable future, to establish complete “free banking” and place
all banking transactions, including the granting of credit, under
ordinary commercial law. Those who speak and write today on
behalf of “stabilization,” “maintenance of purchasing power” and
“elimination of the trade cycle,” can certainly not call this more
limited approach “extreme.” On the contrary! They will reject this
suggestion as not going far enough. They are demanding much
more. In their view, the “price level” should be maintained by
countering rising prices with a restriction in the circulation of
fiduciary media and, similarly, countering falling prices by the
expansion of fiduciary media.

The arguments that may be advanced in favor of this modest

program have already been set forth above in the first part of this
work. In our judgment, the arguments which militate against all
monetary manipulation are so great that placing decisions as to the
formation of purchasing power in the hands of banking officials,
parliaments and governments, thus making it subject to shifting
political influences, must be avoided. The methods available for
measuring changes in purchasing power are necessarily defective.
The effect of the various maneuvers, intended to influence pur-
chasing power, cannot be quantitatively established—neither in
advance nor even after they have taken place. Thus proposals
which amount only to making approximate adjustments in pur-
chasing power must be considered completely impractical.

Nothing more will be said here concerning the fundamental

absurdity of the concept of “stable purchasing power” in a chang-
ing economy. This has already been discussed at some length. For
practical economic policy, the only problem is what inflationist
or restrictionist measures to consider for the partial adjustment
of severe price declines or increases. Such measures, carried out
in stages, step by step, through piecemeal international agree-
ments, would benefit either creditors or debtors. However, one
question remains: Whether, in view of the conflicts among inter-
ests, agreements on this issue could be reached among nations.

Monetary Stabilization and Cyclical Policy — 151

152 — The Causes of the Economic Crisis

The viewpoints of creditors and debtors will no doubt differ
widely, and these conflicts of interest will complicate still more
the manipulation of money internationally, than on the national
level.

3. I

NTERNATIONAL

OMPLICATIONS

It is also possible to consider monetary manipulation as an

aspect of national economic policy, and take steps to regulate the
value of money independently, without reference to the interna-
tional situation. According to Keynes,

if there is a choice

between stabilization of prices and stabilization of the foreign
exchange rate, the decision should be in favor of price stabiliza-
tion and against stabilization of the rate of exchange. However, a
nation which chose to proceed in this way would create interna-
tional complications because of the repercussions its policy
would have on the content of contractual obligations.

For example, if the United States were to raise the purchasing

power of the dollar over that of its present gold parity, the inter-
ests of foreigners who owed dollars would be very definitely
affected as a result. Then again, if debtor nations were to try to
depress the purchasing power of their monetary unit, the inter-
ests of creditors would be impaired. Irrespective of this, every
change in value of a monetary unit would unleash influences on
foreign trade. A rise in its value would foster increased imports,
while a fall in its value would be recognized as the power to
increase exports.

In recent generations, consideration of these factors has led to

pressure for a single monetary standard based on gold. If this sit-
uation is ignored, then it will certainly not be possible to fashion
monetary value so that it will generally be considered satisfac-
tory. In view of the ideas prevailing today with respect to trade
policy, especially in connection with foreign relations, a rising
value for money is not considered desirable, because of its power
to promote imports and to hamper exports.

John Maynard Keynes, A Tract on Monetary Reform (London, 1923;

New York, 1924), pp. 156ff.

Monetary Stabilization and Cyclical Policy — 153

Attempts to introduce a national policy, so as to influence

prices independently of what is happening abroad, while still
clinging to the gold standard and the corresponding rates of
exchange, would be completely unworkable. There is no need to
say any more about this.

4. T

UTURE

The obstacles, which militate against a policy aimed at the com-

plete elimination of cyclical changes, are truly considerable. For
that reason, it is not very likely that such new approaches to mon-
etary and banking policy, that limit the creation of fiduciary media,
will be followed. It will probably not be resolved to prohibit entirely
the expansion of fiduciary media. Nor is it likely that expansion
will be limited to only the quantities sufficient to counteract a def-
inite and pronounced trend toward generally declining prices.
Perplexed as to how to evaluate the serious political and economic
doubts which are raised in opposition to every kind of manipula-
tion of the value of money, the people will probably forgo decisive
action and leave it to the central bank managers to proceed, case
by case, at their own discretion. Just as in the past, cyclical policy
of the near future will be surrendered into the hands of the men
who control the conduct of the great central banks and those who
influence their ideas, i.e., the moulders of public opinion.

Nevertheless, the cyclical policy of the future will differ appre-

ciably from its predecessor. It will be knowingly based on the
Circulation Credit Theory of the Trade Cycle. The hopeless
attempt to reduce the loan rate indefinitely by continuously
expanding circulation credit will not be revived in the future. It
may be that the quantity of fiduciary media will be intentionally
expanded or contracted in order to influence purchasing power.
However, the people will no longer be under the illusion that
technical banking procedures can make credit cheaper and thus
create prosperity without its having repercussions.

The only way to do away with, or even to alleviate, the periodic

return of the trade cycle—with its denouement, the crisis—is to
reject the fallacy that prosperity can be produced by using bank-
ing procedures to make credit cheap.

155

ATURE AND

OLE OF THE

ARKET

1. T

ARXIAN

“A

NARCHY OF

RODUCTION

” M

YTH

he Marxian critique censures the capitalistic social order
for the anarchy and planlessness of its production meth-
ods. Allegedly, every entrepreneur produces blindly,

guided only by his desire for profit, without any concern as to
whether his action satisfies a need. Thus, for Marxists, it is not
surprising if severe disturbances appear again and again in the
form of periodical economic crises. They maintain it would be
futile to fight against all this with capitalism. It is their contention
that only socialism will provide the remedy by replacing the anar-
chistic profit economy with a planned economic system aimed at
the satisfaction of needs.

Strictly speaking, the reproach that the market economy is

“anarchistic” says no more than that it is just not socialistic. That
is, the actual management of production is not surrendered to

[Die Ursachen der Wirtschaftskrise: Ein Vortrag (Tübingen: J.C.B. Mohr,
Paul Siebeck, 1931). Presented February 28, 1931, at Teplitz-Schönau,
Czechoslovakia, before an assembly of German industrialists (Deutscher
Hauptverband der Industrie).—Ed.]

AUSES OF THE

CONOMIC

RISIS

DDRESS

(1931)

a central office which directs the employment of all factors of
production, but this is left to entrepreneurs and owners of the
means of production. Calling the capitalistic economy “anarchis-
tic,” therefore, means only that capitalistic production is not a
function of governmental institutions.

Yet, the expression “anarchy” carries with it other connota-

tions. We usually use the word “anarchy” to refer to social
conditions in which, for lack of a governmental apparatus of force
to protect peace and respect for the law, the chaos of continual
conflict prevails. The word “anarchy,” therefore, is associated
with the concept of intolerable conditions. Marxian theorists
delight in using such expressions. Marxian theory needs the
implications such expressions give to arouse the emotional sym-
pathies and antipathies that are likely to hinder critical analysis.
The “anarchy of production” slogan has performed this service to
perfection. Whole generations have permitted it to confuse
them. It has influenced the economic and political ideas of all
currently active political parties and, to a remarkable extent, even
those parties which loudly proclaim themselves anti-Marxist.

2. T

OLE AND

ULE OF

ONSUMERS

Even if the capitalistic method of production were “anarchis-

tic,” i.e., lacking systematic regulation from a central office, and
even if individual entrepreneurs and capitalists did, in the hope of
profit, direct their actions independently of one another, it is still
completely wrong to suppose they have no guide for arranging
production to satisfy need. It is inherent in the nature of the cap-
italistic economy that, in the final analysis, the employment of
the factors of production is aimed only toward serving the wishes
of consumers. In allocating labor and capital goods, the entrepre-
neurs and the capitalists are bound, by forces they are unable to
escape, to satisfy the needs of consumers as fully as possible,
given the state of economic wealth and technology. Thus, the
contrast drawn between the capitalistic method of production, as
production for profit, and the socialistic method, as production
for use, is completely misleading. In the capitalistic economy, it is
consumer demand that determines the pattern and direction of

156 — The Causes of the Economic Crisis

production, precisely because entrepreneurs and capitalists must
consider the profitability of their enterprises.

An economy based on private ownership of the factors of pro-

duction becomes meaningful through the market. The market
operates by shifting the height of prices so that again and again
demand and supply will tend to coincide. If demand for a good
goes up, then its price rises, and this price rise leads to an
increase in supply. Entrepreneurs try to produce those goods the
sale of which offers them the highest possible gain. They expand
production of any particular item up to the point at which it
ceases to be profitable. If the entrepreneur produces only those
goods whose sale gives promise of yielding a profit, this means
that they are producing no commodities for the manufacture of
which labor and capital goods must be used which are needed for
the manufacture of other commodities more urgently desired by
consumers.

In the final analysis, it is the consumers who decide what shall

be produced, and how. The law of the market compels entrepre-
neurs and capitalists to obey the orders of consumers and to
fulfill their wishes with the least expenditure of time, labor and
capital goods. Competition on the market sees to it that entre-
preneurs and capitalists, who are not up to this task, will lose
their position of control over the production process. If they can-
not survive in competition, that is, in satisfying the wishes of
consumers cheaper and better, then they suffer losses which
diminish their importance in the economic process. If they do
not soon correct the shortcomings in the management of their
enterprise and capital investment, they are eliminated completely
through the loss of their capital and entrepreneurial position.
Henceforth, they must be content as employees with a more
modest role and reduced income.

3. P

RODUCTION FOR

ONSUMPTION

The law of the market applies to labor also. Like other factors

of production, labor is also valued according to its usefulness in
satisfying human wants. Its price, the wage rate, is a market
phenomenon like any other market phenomenon, determined by

The Causes of the Economic Crisis: An Address — 157

supply and demand, by the value the product of labor has in the
eye of consumers. By shifting the height of wages, the market
directs workers into those branches of production in which they
are most urgently needed. Thus the market supplies to each type
of employment that quality and quantity of labor needed to sat-
isfy consumer wants in the best possible way.

In the feudal society, men became rich by war and conquest

and through the largesse of the sovereign ruler. Men became
poor if they were defeated in battle or if they fell from the
monarch’s good graces. In the capitalistic society, men become
rich—directly as the producer of consumers’ goods, or indi-
rectly as the producer of raw materials and semi-produced
factors of production—by serving consumers in large numbers.
This means that men who become rich in the capitalistic soci-
ety are serving the people. The capitalistic market economy is a
democracy in which every penny constitutes a vote. The wealth
of the successful businessman is the result of a consumer
plebiscite. Wealth, once acquired, can be preserved only by
those who keep on earning it anew by satisfying the wishes of
consumers.

The capitalistic social order, therefore, is an economic democ-

racy in the strictest sense of the word. In the last analysis, all
decisions are dependent on the will of the people as consumers.
Thus, whenever there is a conflict between consumers’ views and
those of the business managers, market pressures assure that the
views of the consumers win out eventually. This is certainly
something very different from the pseudo-economic democracy
toward which the labor unions are aiming. In such a system as
they propose, the people are supposed to direct production as
producers, not as consumers. They would exercise influence, not
as buyers of products, but as sellers of labor, that is, as sellers of
one of the factors of production. If this system were carried out,
it would disorganize the entire production apparatus and thus
destroy our civilization. The absurdity of this position becomes
apparent simply upon considering that production is not an end
in itself. Its purpose is to serve consumption.

158 — The Causes of the Economic Crisis

4. T

ERNICIOUSNESS OF A

“P

RODUCERS

’ P

OLICY

”

Under pressure of the market, entrepreneurs and capitalists

must order production so as to carry out the wishes of
consumers. The arrangements they make and what they ask of
workers is always determined by the need to satisfy the most
urgent wants of consumers. It is precisely this which guarantees
that the will of the consumer shall be the only guideline for busi-
ness. Yet capitalism is usually reproached for placing the logic of
expediency above sentiment and arranging things in the econ-
omy dispassionately and impersonally for monetary profit only. It
is because the market compels the entrepreneur to conduct his
business so that he derives from it the greatest possible return
that the wants of consumers are covered in the best and cheapest
way. If potential profit were no longer taken into consideration by
enterprises, but instead the workers’ wishes became the criterion,
so that work was arranged for their greatest convenience, then
the interests of consumers would be injured. If the entrepreneur
aims at the highest possible profit, he performs a service to soci-
ety in managing an enterprise. Whoever hinders him from doing
this, in order to give preference to considerations other than
those of business profits, acts against the interests of society and
imperils the satisfaction of consumer needs.

Workers and consumers are, of course, identical. If we distin-

guish between them, we are only differentiating mentally
between their respective functions within the economic frame-
work. We should not let this lead us into the error of thinking
they are different groups of people. The fact that entrepreneurs
and capitalists also are consuming plays a less important role
quantitatively; for the market economy, the significant consump-
tion is mass consumption. Directly or indirectly, capitalistic
production serves primarily the consumption of the masses. The
only way to improve the situation of the consumer, therefore, is
to make enterprises still more productive, or as people may say
today, to “rationalize” still further. Only if one wants to reduce
consumption, should one urge what is known as “producers’ pol-
icy”—specifically the adoption of those measures which place the
interests of producers over those of consumers.

The Causes of the Economic Crisis: An Address — 159

Opposition to the economic laws which the market decrees

for production must always be at the expense of consumption.
This should be kept in mind whenever interventions are advo-
cated to free producers from the necessity of complying with the
market.

The market processes give meaning to the capitalistic econ-

omy. They place entrepreneurs and capitalists in the service of
satisfying the wants of consumers. If the workings of these com-
plex processes are interfered with, then disturbances are brought
about which hamper the adjustment of supply to demand and
lead production astray, along paths which keep them from attain-
ing the goal of economic action—i.e., the satisfaction of wants.

These disturbances constitute the economic crisis.

II.

YCLICAL

HANGES IN

USINESS

ONDITIONS

1. R

OLE OF

NTEREST

ATES

In our economic system, times of good business commonly

alternate more or less regularly with times of bad business.
Decline follows economic upswing, upswing follows decline, and
so on. The attention of economic theory has quite understand-
ably been greatly stimulated by this problem of cyclical changes
in business conditions. In the beginning, several hypotheses were
set forth, which could not stand up under critical examination.
However, a theory of cyclical fluctuations was finally developed
which fulfilled the demands legitimately expected from a scien-
tific solution to the problem. This is the circulation credit theory,
usually called the monetary theory of the trade cycle. This theory
is generally recognized by science. All cyclical policy measures,
which are taken seriously, proceed from the reasoning which lies
at the root of this theory.

160 — The Causes of the Economic Crisis

According to the circulation credit theory (monetary theory

of the trade cycle), cyclical changes in business conditions stem
from attempts to reduce artificially the interest rates on loans
through measures of banking policy—expansion of bank credit
by the issue or creation of additional fiduciary media (that is
banknotes and/or checking deposits not covered 100 percent by
gold). On a market, which is not disturbed by the interference of
such an “inflationist” banking policy, interest rates develop at
which the means are available to carry out all the plans and enter-
prises that are initiated. Such unhampered market interest rates
are known as “natural” or “static” interest rates. If these interest
rates were adhered to, then economic development would pro-
ceed without interruption—except for the influence of natural
cataclysms or political acts such as war, revolution, and the like.
The fact that economic development follows a wavy pattern must
be attributed to the intervention of the banks through their inter-
est rate policy.

The point of view prevails generally among politicians, busi-

ness people, the press and public opinion that reducing the
interest rates below those developed by market conditions is a
worthy goal for economic policy, and that the simplest way to
reach this goal is through expanding bank credit. Under the
influence of this view, the attempt is undertaken, again and again,
to spark an economic upswing through granting additional loans.
At first, to be sure, the result of such credit expansion comes up
to expectations. Business is revived. An upswing develops.
However, the stimulating effect emanating from the credit
expansion cannot continue forever. Sooner or later, a business
boom created in this way must collapse.

At the interest rates which developed on the market, before

any interference by the banks through the creation of additional
circulation credit, only those enterprises and businesses
appeared profitable for which the needed factors of production
were available in the economy. The interest rates are reduced
through the expansion of credit, and then some businesses,
which did not previously seem profitable, appear to be profitable.
It is precisely the fact that such businesses are undertaken that

The Causes of the Economic Crisis: An Address — 161

initiates the upswing. However, the economy is not wealthy
enough for them. The resources they need for completion are not
available. The resources they need must first be withdrawn from
other enterprises. If the means had been available, then the credit
expansion would not have been necessary to make the new proj-
ects appear possible.

2. T

EQUEL OF

REDIT

XPANSION

Credit expansion cannot increase the supply of real goods. It

merely brings about a rearrangement. It diverts capital invest-
ment away from the course prescribed by the state of economic
wealth and market conditions. It causes production to pursue
paths which it would not follow unless the economy were to
acquire an increase in material goods. As a result, the upswing
lacks a solid base. It is not real prosperity. It is illusory prosperity.
It did not develop from an increase in economic wealth. Rather,
it arose because the credit expansion created the illusion of such
an increase. Sooner or later it must become apparent that this
economic situation is built on sand.

Sooner or later, credit expansion, through the creation of

additional fiduciary media, must come to a standstill. Even if the
banks wanted to, they could not carry on this policy indefinitely,
not even if they were being forced to do so by the strongest pres-
sure from outside. The continuing increase in the quantity of
fiduciary media leads to continual price increases. Inflation can
continue only so long as the opinion persists that it will stop in
the foreseeable future. However, once the conviction gains a
foothold that the inflation will not come to a halt, then a panic
breaks out. In evaluating money and commodities, the public
takes anticipated price increases into account in advance. As a
consequence, prices race erratically upward out of all bounds.
People turn away from using money which is compromised by
the increase in fiduciary media. They “flee” to foreign money,
metal bars, “real values,” barter. In short, the currency breaks
down.

The policy of expanding credit is usually abandoned well

before this critical point is reached. It is discontinued because of

162 — The Causes of the Economic Crisis

the situation which develops in international trade relations and
also, especially, because of experiences in previous crises, which
have frequently led to legal limitations on the right of the central
banks to issue notes and create credit. In any event, the policy of
expanding credit must come to an end—if not sooner due to a
turnabout by the banks, then later in a catastrophic breakdown.
The sooner the credit expansion policy is brought to a stop, the
less harm will have been done by the misdirection of entrepre-
neurial activity, the milder the crisis and the shorter the following
period of economic stagnation and general depression.

The appearance of periodically recurring economic crises is

the necessary consequence of repeatedly renewed attempts to
reduce the “natural” rates of interest on the market by means of
banking policy. The crises will never disappear so long as men
have not learned to avoid such pump-priming, because an artifi-
cially stimulated boom must inevitably lead to crisis and
depression.

III.

RESENT

RISIS

The crisis from which we are now suffering is also the out-

come of a credit expansion. The present crisis is the unavoidable
sequel to a boom. Such a crisis necessarily follows every boom
generated by the attempt to reduce the “natural rate of interest”
through increasing the fiduciary media. However, the present
crisis differs in some essential points from earlier crises, just as
the preceding boom differed from earlier economic upswings.

The most recent boom period did not run its course com-

pletely, at least not in Europe. Some countries and some
branches of production were not generally or very seriously
affected by the upswing which, in many lands, was quite turbu-
lent. A bit of the previous depression continued, even into the
upswing. On that account—in line with our theory and on the

The Causes of the Economic Crisis: An Address — 163

basis of past experience—one would assume that this time the
crisis will be milder. However, it is certainly much more severe
than earlier crises and it does not appear likely that business con-
ditions will soon improve.

The unprofitability of many branches of production and the

unemployment of a sizable portion of the workers can obviously
not be due to the slowdown in business alone. Both the unprof-
itability and the unemployment are being intensified right now
by the general depression. However, in this postwar period, they
have become lasting phenomena which do not disappear entirely
even in the upswing. We are confronted here with a new prob-
lem, one that cannot be answered by the theory of cyclical
changes alone.

Let us consider, first of all, unemployment.

A. U

NEMPLOYMENT

1. T

ARKET

AGE

ATE

ROCESS

Wage rates are market phenomena, just as interest rates and

commodity prices are. Wage rates are determined by the produc-
tivity of labor. At the wage rates toward which the market is
tending, all those seeking work find employment and all entre-
preneurs find the workers they are seeking. However, the
interrelated phenomena of the market from which the “static” or
“natural” wage rates evolve are always undergoing changes that
generate shifts in wage rates among the various occupational
groups. There is also always a definite time lag before those seek-
ing work and those offering work have found one another. As a
result, there are always sure to be a certain number of unem-
ployed.

Just as there are always houses standing empty and persons

looking for housing on the unhampered market, just as there are
always unsold wares in markets and persons eager to purchase
wares they have not yet found, so there are always persons who

164 — The Causes of the Economic Crisis

are looking for work. However, on the unhampered market, this
unemployment cannot attain vast proportions. Those capable of
work will not be looking for work over a considerable period—
many months or even years—without finding it.

If a worker goes a long time without finding the employment

he seeks in his former occupation, he must either reduce the
wage rate he asks or turn to some other field where he hopes to
obtain a higher wage than he can now get in his former occupa-
tion. For the entrepreneur, the employment of workers is a part
of doing business. If the wage rate drops, the profitability of his
enterprise rises and he can employ more workers. So by reducing
the wage rates they seek, workers are in a position to raise the
demand for labor.

This in no way means that the market would tend to push

wage rates down indefinitely. Just as competition among workers
has the tendency to lower wages, so does competition among
employers tend to drive them up again. Market wage rates thus
develop from the interplay of demand and supply.

The force with which competition among employers affects

workers may be seen very clearly by referring to the two mass
migrations which characterized the nineteenth and early twenti-
eth centuries. The oft-cited exodus from the land rested on the
fact that agriculture had to release workers to industry.
Agriculture could not pay the higher wage rates which industry
could and which, in fact, industry had to offer in order to attract
workers from housework, hand labor and agriculture. The migra-
tion of workers was continually out of regions where wages were
held down by the inferiority of general conditions of production
and into areas where the productivity made it possible to pay
higher wages.

Out of every increase in productivity, the wage earner

receives his share. For profitable enterprises seeking to expand,
the only means available to attract more workers is to raise wage
rates. The prodigious increase in the living standard of the
masses, that accompanied the development of capitalism, is the

The Causes of the Economic Crisis: An Address — 165

result of the rise in real wages which kept abreast of the increase
in industrial productivity.

This self-adjusting process of the market is severely dis-

turbed now by the interference of unions whose effectiveness
evolved under the protection and with the assistance of govern-
mental power.

2. T

ABOR

NION

AGE

ATE

ONCEPT

According to labor union doctrine, wages are determined by

the balance of power. According to this view, if the unions suc-
ceed in intimidating the entrepreneurs, through force or threat
of force, and holding nonunion workers off with the use of brute
force, then wage rates can be set at whatever height desired
without the appearance of any undesirable side effects. Thus, the
conflict between employers and workers seems to be a struggle
in which justice and morality are entirely on the side of the
workers. Interest on capital and entrepreneurial profit appear to
be ill-gotten gains. They are alleged to come from the exploita-
tion of the worker and should be set aside for unemployment
relief. This task, according to union doctrine, should be accom-
plished not only by increased wage rates but also through taxes
and welfare spending which, in a regime dominated by pro-labor
union parties, is to be used indirectly for the benefit of the work-
ers.

The labor unions use force to attain their goals. Only union

members, who ask the established union wage rate and who work
according to union-prescribed methods, are permitted to work
in industrial undertakings. Should an employer refuse to accept
union conditions, there are work stoppages. Workers who would
like to work, in spite of the reproach heaped on such an under-
taking by the union, are forced by acts of violence to give up any
such plan. This tactic on the part of the labor unions presup-
poses, of course, that the government at least acquiesces in their
behavior.

166 — The Causes of the Economic Crisis

3. T

AUSE OF

NEMPLOYMENT

If the government were to proceed against those who molest

persons willing to work and those who destroy machines and
industrial equipment in enterprises that want to hire strikebreak-
ers, as it normally does against the other perpetrators of violence,
the situation would be very different. However, the characteristic
feature of modern governments is that they have capitulated to
the labor unions.

The unions now have the power to raise wage rates above

what they would be on the unhampered market. However, inter-
ventions of this type evoke a reaction. At market wage rates,
everyone looking for work can find work. Precisely this is the
essence of market wages—they are established at the point at
which demand and supply tend to coincide. If the wage rates are
higher than this, the number of employed workers goes down.
Unemployment then develops as a lasting phenomenon. At the
wage rates established by the unions, a substantial portion of the
workers cannot find any work at all. Wage increases for a portion
of the workers are at the expense of an ever more sharply rising
number of unemployed.

Those without work would probably tolerate this situation for

a limited time only. Eventually they would say: “Better a lower
wage, than no wage at all.” Even the labor unions could not with-
stand an assault by hundreds of thousands, or millions of
would-be workers. The labor union policy of holding off those
willing to work would collapse. Market wage rates would prevail
once again. It is here that unemployment relief is brought into
play and its role [in keeping workers from competing on the labor
market] needs no further explanation.

Thus, we see that unemployment, as a long-term mass phe-

nomenon, is the consequence of the labor union policy of driving
wage rates up. Without unemployment relief, this policy would
have collapsed long ago. Thus, unemployment relief is not a
means for alleviating the want caused by unemployment, as is
assumed by misguided public opinion. It is on the contrary, one

The Causes of the Economic Crisis: An Address — 167

link in the chain of causes which actually makes unemployment
a long-term mass phenomenon.

4. T

EMEDY FOR

ASS

NEMPLOYMENT

Appreciation of this relationship has certainly become more

widespread in recent years. With all due caution and with a thou-
sand reservations, it is even generally admitted that labor union
wage policy is responsible for the extent and duration of unem-
ployment. All serious proposals for fighting unemployment
depend on recognition of this theory. When proposals are made
to reimburse entrepreneurs, directly or indirectly from public
funds, for a part of their wage costs, if they seek to recruit the
unemployed in their plants, then it is being recognized that
entrepreneurs would employ more workers at a lower wage scale.
If it is suggested that the national or municipal government
undertake projects without considering their profitability, proj-
ects which private enterprise does not want to carry out because
they are not profitable, this too simply means that wage rates are
so high that they do not permit these undertakings to make prof-
its. (Incidentally, it may be noted that this latter proposal entirely
overlooks the fact that a government can build and invest only if
it withdraws the necessary means from the private economy. So
putting this proposal into effect must lead to just as much new
unemployment on one side as it eliminates on the other.)

Then again, if a reduction in hours of work is considered, this

too implies recognition of our thesis. For after all, this proposal
seeks to shorten the working hours in such a way that all the
unemployed will find work, and so that each individual worker, to
the extent that he will have less work than he does today, will be
entitled to receive less pay. Obviously this assumes that no more
work is to be found at the present rate of pay than is currently
being provided. The fact that wage rates are too high to give
employment to everyone is also admitted by anyone who asks
workers to increase production without raising wage rates. It
goes without saying that, wherever hourly wages prevail, this
means a reduction in the price of labor. If one assumes a cut in
the piece rate, labor would also be cheaper where piece work

168 — The Causes of the Economic Crisis

prevails. Obviously then, the crucial factor is not the absolute
height of hourly or daily wage rates, but the wage costs which
yield a definite output.

However, the demand to reduce wage rates is now also being

made openly. In fact, wage rates have already been substantially
lowered in many enterprises. Workers are called upon by the
press and government officials to relax some of their wage
demands and to make a sacrifice for the sake of the general wel-
fare. To make this bearable, the prospect of price cuts is held out
to the workers, and the governments try to secure price reduc-
tions by putting pressure on the entrepreneurs.

However, it is not a question of reducing wage rates. This

bears repeating with considerable emphasis. The problem is to
re-establish freedom in the determination of wage rates. It is true
that in the beginning this would lead to a reduction in money
wage rates for many groups of workers. How far this drop in wage
rates must go to eliminate unemployment as a lasting phenome-
non can be shown only by the free determination of wage rates
on the labor market. Negotiations between union leaders and
business combinations, with or without the cooperation of offi-
cials, decisions by arbitrators or similar techniques of
interventionism are no substitute. The determination of wage
rates must become free once again. The formation of wage rates
should be hampered neither by the clubs of striking pickets nor
by government’s apparatus of force. Only if the determination of
wage rates is free, will they be able to fulfill their function of
bringing demand and supply into balance on the labor market.

5. T

FFECTS OF

OVERNMENT

NTERVENTION

The demand that a reduction in prices be tied in with the

reduction in wage rates ignores the fact that wage rates appear
too high precisely because wage reductions have not accompa-
nied the practically universal reduction in prices. Granted, the
prices of many articles could not join the drop in prices as they
would on an unhampered market, either because they were pro-
tected by special governmental interventions (tariffs, for
instance) or because they contained substantial costs in the form

The Causes of the Economic Crisis: An Address — 169

of taxes and higher than unhampered market wage rates. The
decline in the price of coal was held up in Germany because of
the rigidity of wage rates which, in the mining of hard coal, come
to 56 percent of the value of production.

The domestic price of

iron in Germany can remain above the world market price only
because tariff policy permits the creation of a national iron cartel
and international agreements among national cartels. Here too,
one need ask only that those interferences which thwart the free
market formation of prices be abolished. There is no need to call
for a price reduction to be dictated by government, labor unions,
public opinion or anyone else.

Against the assertion that unemployment is due to the extreme

height of wages, it is entirely wrong to introduce the argument
that wages are still higher elsewhere. If workers enjoyed complete
freedom to move, there would be a tendency throughout the eco-
nomic world for wage rates for similar work to be uniform.
However, in recent years, the freedom of movement for workers
has been considerably reduced, even almost completely abolished.
The labor unions ask the government to forbid the migration of
workers from abroad lest such immigrants frustrate union policy
by underbidding the wage rates demanded by the unions.

If there had been no immigration restrictions, millions of

workers would have migrated from Europe to the United States
in recent decades. This migration would have reduced the differ-
ences between American and European wage rates. By stopping
immigration into the United States, wage rates are raised there
and lowered in Europe. It is not the hardheartedness of European
capitalists, but the labor policy of the United States (and of
Australia and other foreign countries too) which is responsible
for the size of the gap between wage rates here in Europe and
overseas. After all, the workers in most European countries fol-
low the same policy of keeping out foreign competitors. They,
too, restrict or even prohibit foreign workers from coming into
their countries so as to protect in this way the labor union policy
of holding up wage rates.

170 — The Causes of the Economic Crisis

[This address to German industrialists was given in 1931.—Ed.]

6. T

ROCESS OF

ROGRESS

A popular doctrine makes “rationalization” responsible for

unemployment. As a result of “rationalization,” practically univer-
sal “rationalization,” it is held that those workers who cannot find
employment anywhere become surplus. “Rationalization” is a
modern term which has been in use for only a short time. The
concept, however, is by no means new. The capitalistic entrepre-
neur is continually striving to make production and marketing
more efficient. There have been times when the course of “ration-
alization” has been relatively more turbulent than in recent years.
“Rationalization” was taking place on a large scale when the black-
smith was replaced by the steel and rolling mills, handweaving
and spinning by mechanical looms and spindles, the stagecoach
by the steam engine—even though the word “rationalization” was
not then known and even though there were then no officials,
advisory boards and commissions with reports, programs and
dogmas such as go along with the technical revolution today.

Industrial progress has always set workers free. There have

always been shortsighted persons who, fearing that no employ-
ment would be found for the released workers, have tried to stop
the progress. Workers have always resisted technical improve-
ment and writers have always been found to justify this
opposition. Every increase in the productivity of labor has been
carried out in spite of the determined resistance of governments,
“philanthropists,” “moralists” and workers. If the theory which
attributes unemployment to “rationalization” were correct, then
99 out of 100 workers at the end of the nineteenth century would
have been out of work.

Workers released by the introduction of industrial technology

find employment in other positions. The ranks of newly develop-
ing branches of industry are filled with these workers. The
additional commodities available for consumption, which come
in the wake of “rationalization,” are produced with their labor.
Today this process is hampered by the fact that those workers
who are released receive unemployment relief and so do not con-
sider it necessary to change their occupation and place of work in

The Causes of the Economic Crisis: An Address — 171

order to find employment again. It is not on account of “rational-
ization,” but because the unemployed are relieved of the necessity
of looking around for new work, that unemployment has become
a lasting phenomenon.

B. P

RICE

ECLINES AND

RICE

UPPORTS

1. T

UBSIDIZATION OF

URPLUSES

The opposition to market determination of prices is not lim-

ited to wages and interest rates. Once the stand is taken not to
permit the structure of market prices to work its effect on pro-
duction there is no reason to stop short of commodity prices.

If the prices of coal, sugar, coffee or rye go down, this means

that consumers are asking more urgently for other commodities.
As a result of the decline in such prices, some concerns produc-
ing these commodities become unprofitable and are forced to
reduce production or shut down completely. The capital and
labor thus released are then shifted to other branches of the
economy in order to produce commodities for which a stronger
demand prevails.

However, politics interferes once again. It tries to hinder the

adjustment of production to the requirements of consumption—by
coming to the aid of the producer who is hurt by price reductions.

In recent years, capitalistic methods of production have been

applied more and more extensively to the production of raw
materials. As always, wherever capitalism prevails, the result has
been an astonishing increase in productivity. Grain, fruit, meat,
rubber, wool, cotton, oil, copper, coal, minerals are all much more
readily available now than they were before the war and in the
early postwar years. Yet, it was just a short while ago that govern-
ments believed they had to devise ways and means to ease the
shortage of raw materials. When, without any help from them,
the years of plenty came, they immediately took up the cudgels to
prevent this wealth from having its full effect for economic well-
being. The Brazilian government wants to prevent the decline in

172 — The Causes of the Economic Crisis

the price of coffee so as to protect plantation owners who oper-
ate on poorer soil or with less capital from having to cut down or
give up cultivation. The much richer United States government
wants to stop the decline in the price of wheat and in many other
prices because it wants to relieve the farmer working on poorer
soil of the need to adjust or discontinue his enterprise.

Tremendous sums are sacrificed throughout the world in

completely hopeless attempts to forestall the effects of the
improvements made under capitalistic production. Billions are
spent in the fruitless effort to maintain prices and in direct sub-
sidy to those producers who are less capable of competing.
Further billions are indirectly used for the same goals, through
protective tariffs and similar measures which force consumers to
pay higher prices. The aim of all these interventions—which
drive prices up so high as to keep in business producers who
would otherwise be unable to meet competition—can certainly
never be attained. However, all these measures delay the process-
ing industries, which use capital and labor, in adjusting their
resources to the new supplies of raw materials produced. Thus
the increase in commodities represents primarily an embarrass-
ment and not an improvement in living standards. Instead of
becoming a blessing for the consumer, the wealth becomes a bur-
den for him, if he must pay for the government interventions in
the form of higher taxes and tariffs.

2. T

EED FOR

EADJUSTMENTS

The cultivation of wheat in central Europe was jeopardized by

the increase in overseas production. Even if European farmers
were more efficient, more skilled in modern methods and better
supplied with capital, even if the prevailing industrial arrangement
were not small and pygmy-sized, wasteful, productivity-hamper-
ing enterprises, these farms on less fertile soil with less favorable
weather conditions, still could not rival the wheat farms of Canada.
Central Europe must reduce its cultivation of grain, as it cut down
on the breeding of sheep decades ago. The billions which the hope-
less struggle against the better soil of America has already cost is

The Causes of the Economic Crisis: An Address — 173

money uselessly squandered. The future of central European agri-
culture does not lie in the cultivation of grain. Denmark and
Holland have shown that agriculture can exist in Europe even
without the protection of tariffs, subsidies and special privileges.
However, the economy of central Europe will depend in the future,
to a still greater extent than before, on industry.

By this time, it is easy to understand the paradox of the phe-

nomenon that higher yields in the production of raw materials and
foodstuffs cause harm. The interventions of governments and of
the privileged groups, which seek to hinder the adjustment of the
market to the situation brought about by new circumstances,
mean that an abundant harvest brings misfortune to everyone.

In recent decades, in almost all countries of the world, attempts

have been made to use high protective tariffs to develop economic
self-sufficiency (autarky) among smaller and middle-sized
domains. Tremendous sums have been invested in manufacturing
plants for which there was no economic demand. The result is that
we are rich today in physical structures, the facilities of which can-
not be fully exploited or perhaps not even used at all.

The result of all these efforts to annul the laws which the mar-

ket decrees for the capitalistic economy is, briefly, lasting
unemployment of many millions, unprofitability for industry and
agriculture, and idle factories. As a result of all these, political
controversies become seriously aggravated, not only within
countries but also among nations.

C. T

OLICY

1. T

NTI

-C

APITALISTIC

ENTALITY

The harmful influence of politics on the economy goes

far beyond the consequences of the interventionist measures
previously discussed.

There is no need to mention the mobilization policies of the

government, the continual controversies constantly emerging
from nationalistic conflicts in multi-lingual communities and the

174 — The Causes of the Economic Crisis

anxiety caused by saber rattling ministers and political parties.
All of these things create unrest. Thus, they may indirectly aggra-
vate the crisis situation and especially the uneasiness of the
business world.

Financial policy, however, works directly.

The share of the people’s income which government exacts for

its expenditures, even entirely apart from military spending, is
continually rising. There is hardly a single country in Europe in
which tremendous sums are not being wasted on largely mis-
guided national and municipal economic undertakings.
Everywhere, we see government continually taking over new
tasks when it is hardly able to carry out satisfactorily its previous
obligations. Everywhere, we see the bureaucracy swell in size. As
a result, taxes are rising everywhere. At a time when the need to
reduce production costs is being universally discussed, new taxes
are being imposed on production. Thus the economic crisis is, at
the same time, a crisis in public finance also. This crisis in public
finance will not be resolved without a complete revision of gov-
ernment operations.

One widely held view, which easily dominates public opinion

today, maintains that taxes on wealth are harmless. Thus every
governmental expenditure is justified, if the funds to pay for it are
not raised by taxing mass consumption or imposing income taxes
on the masses. This idea, which must be held responsible for the
mania toward extravagance in government expenditures, has
caused those in charge of government financial policy to lose
completely any feeling of a need for economy. Spending a large
part of the people’s income in senseless ways—in order to carry
out futile price support operations, to undertake the hopeless
task of trying to support with subsidies unprofitable enterprises
which could not otherwise survive, to cover the losses of unprof-
itable public enterprises and to finance the unemployment of
millions—would not be justified, even if the funds for the pur-
pose were collected in ways that do not aggravate the crisis.
However, tax policy is aimed primarily, or even exclusively, at
taxing the yield on capital and the capital itself. This leads to a
slowing down of capital formation and even, in many countries,

The Causes of the Economic Crisis: An Address — 175

to capital consumption. However, this concerns not capitalists
only, as generally assumed. The quantitatively lower the ratio of
capital to workers, the lower the wage rates which develop on the
free labor market. Thus, even workers are affected by this policy.

Because of tax legislation, entrepreneurs must frequently oper-

ate their businesses differently from the way reason would
otherwise indicate. As a result, productivity declines and conse-
quently so does the provision of goods for consumption. As might
be expected, capitalists shy away from leaving capital in countries
with the highest taxation and turn to lands where taxes are lower.
It becomes more difficult, on that account, for the system of pro-
duction to adjust to the changing pattern of economic demand.

Financial policy certainly did not create the crisis. However, it

does contribute substantially to making it worse.

D. G

OLD

RODUCTION

1. T

ECLINE IN

RICES

One popular doctrine blames the crisis on the insufficiency of

gold production.

The basic error in this attempt to explain the crisis rests on

equating a drop in prices with a crisis. A slow, steady, downward
slide in the prices of all goods and services could be explained by
the relationship to the production of gold. Businessmen have
become accustomed to a relationship of the demand for, and sup-
ply of, gold from which a slow steady rise in prices emerges as a
secular (continuing) trend. However, they could just as easily
have become reconciled to some other arrangement—and they
certainly would have if developments had made that necessary.
After all, the businessman’s most important characteristic is flex-
ibility. The businessman can operate at a profit, even if the
general tendency of prices is downward, and economic condi-
tions can even improve then too.

The turbulent price declines since 1929 were definitely not gen-

erated by the gold production situation. Moreover, gold

176 — The Causes of the Economic Crisis

production has nothing to do with the fact that the decline in
prices is not universal, nor that it does not specifically involve
wages also.

It is true that there is a close connection between the quantity

of gold produced and the formation of prices. Fortunately, this is
no longer in dispute. If gold production had been considerably
greater than it actually was in recent years, then the drop in
prices would have been moderated or perhaps even prevented
from appearing. It would be wrong, however, to assume that the
phenomenon of the crisis would not then have occurred. The
attempts of labor unions to drive wages up higher than they
would have been on the unhampered market and the efforts of
governments to alleviate the difficulties of various groups of pro-
ducers have nothing to do with whether actual money prices are
higher or lower.

Labor unions no longer contend over the height of money

wages, but over the height of real wages. It is not because of low
prices that producers of rye, wheat, coffee and so on are impelled
to ask for government interventions. It is because of the unprof-
itability of their enterprises. However, the profitability of these
enterprises would be no greater, even if prices were higher. For if
the gold supply had been increased, not only would the prices of
the products which the enterprises in question produce and want
to sell have become or have remained proportionately higher, but
so also would the prices of all the goods which comprise their
costs. Then too, as in any inflation, an increase in the gold supply
does not affect all prices at the same time, nor to the same extent.
It helps some groups in the economy and hurts others. Thus no
reason remains for assuming that an increase in the gold supply
must, in a particular case, improve the situation for precisely
those producers who now have cause to complain about the
unprofitability of their undertakings. It could be that their situa-
tion would not only not be improved; it might even be worsened.

The error in equating the drop in prices with the crisis and,

thus, considering the cause of this crisis to be the insufficient
production of gold is especially dangerous. It leads to the view
that the crisis could be overcome by increasing the fiduciary

The Causes of the Economic Crisis: An Address — 177

media in circulation. Thus the banks are asked to stimulate busi-
ness conditions with the issue of additional banknotes and an
additional credit expansion through credit entries. At first, to be
sure, a boom can be generated in this way. However, as we have
seen, such an upswing must eventually lead to a collapse in the
business outlook and a new crisis.

2. I

NFLATION AS A

“R

EMEDY

”

It is astonishing that sincere persons can either make such a

demand or lend it support. Every possible argument in favor of
such a scheme has already been raised a hundred times, and
demolished a thousand times over. Only one argument is new,
although on that account no less false. This is to the effect that
the higher than unhampered market wage rates can be brought
into proper relationship most easily by an inflation.

This argument shows how seriously concerned our political

economists are to avoid displeasing the labor unions. Although
they cannot help but recognize that wage rates are too high and
must be reduced, they dare not openly call for a halt to such over-
payments. Instead, they propose to outsmart the unions in some
way. They propose that the actual money wage rate remain
unchanged in the coming inflation. In effect, this would amount
to reducing the real wage. This assumes, of course, that the
unions will refrain from making further wage demands in the
ensuing boom and that they will, instead, remain passive while
their real wage rates deteriorate. Even if this entirely unjustified
optimistic expectation is accepted as true, nothing is gained
thereby. A boom caused by banking policy measures must still
lead eventually to a crisis and a depression. So, by this method,
the problem of lowering wage rates is not resolved but simply
postponed.

Yet, all things considered, many may think it advantageous to

delay the unavoidable showdown with labor union policy.
However, this ignores the fact that, with each artificial boom,
large sums of capital are malinvested and, as a result, wasted.
Every diminution in society’s stock of capital must lead toward a
reduction in the “natural” or “static” wage rate. Thus, postponing

178 — The Causes of the Economic Crisis

the decision costs the masses a great deal. Moreover, it will make
the final confrontation still more difficult, rather than easier.

IV.

HERE A

1. T

AUSE OF

IFFICULTIES

The severe convulsions of the economy are the inevitable result

of policies which hamper market activity, the regulator of capital-
istic production. If everything possible is done to prevent the
market from fulfilling its function of bringing supply and demand
into balance, it should come as no surprise that a serious dispro-
portionality between supply and demand persists, that
commodities remain unsold, factories stand idle, many millions
are unemployed, destitution and misery are growing and that
finally, in the wake of all these, destructive radicalism is rampant
in politics.

The periodically returning crises of cyclical changes in busi-

ness conditions are the effect of attempts, undertaken repeatedly,
to underbid the interest rates which develop on the unhampered
market. These attempts to underbid unhampered market interest
rates are made through the intervention of banking policy—by
credit expansion through the additional creation of uncovered
notes and checking deposits—in order to bring about a boom.
The crisis under which we are now suffering is of this type, too.
However, it goes beyond the typical business cycle depression,
not only in scale but also in character—because the interventions
with market processes which evoked the crisis were not limited
only to influencing the rate of interest. The interventions have
directly affected wage rates and commodity prices, too.

With the economic crisis, the breakdown of interventionist

economic policy—the policy being followed today by all govern-
ments, irrespective of whether they are responsible to

The Causes of the Economic Crisis: An Address — 179

parliaments or rule openly as dictatorships—becomes apparent.
This catastrophe obviously comes as no surprise. Economic the-
ory has long been predicting such an outcome to interventionism.

The capitalistic economic system, that is the social system

based on private ownership of the means of production, is
rejected unanimously today by all political parties and govern-
ments. No similar agreement may be found with respect to what
economic system should replace it in the future. Many, although
not all, look to socialism as the goal. They stubbornly reject the
result of the scientific examination of the socialistic ideology,
which has demonstrated the unworkability of socialism. They
refuse to learn anything from the experiences of the Russian and
other European experiments with socialism.

2. T

NWANTED

OLUTION

Concerning the task of present economic policy, however,

complete agreement prevails. The goal is an economic arrange-
ment which is assumed to represent a compromise solution, the
“middle-of-the-road” between socialism and capitalism. To be
sure, there is no intent to abolish private ownership of the means
of production. Private property will be permitted to continue,
although directed, regulated and controlled by government and
by other agents of society’s coercive apparatus. With respect to
this system of interventionism, the science of economics points
out, with incontrovertible logic, that it is contrary to reason, that
the interventions, which go to make up the system, can never
accomplish the goals their advocates hope to attain, and that
every intervention will have consequences no one wanted.

The capitalistic social order acquires meaning and purpose

through the market. Hampering the functions of the market and
the formation of prices does not create order. Instead it leads to
chaos, to economic crisis.

All attempts to emerge from the crisis by new interventionist

measures are completely misguided. There is only one way out of
the crisis: Forgo every attempt to prevent the impact of market
prices on production. Give up the pursuit of policies which seek

180 — The Causes of the Economic Crisis

to establish interest rates, wage rates and commodity prices dif-
ferent from those the market indicates. This may contradict the
prevailing view. It certainly is not popular. Today all govern-
ments and political parties have full confidence in
interventionism and it is not likely that they will abandon their
program. However, it is perhaps not too optimistic to assume
that those governments and parties whose policies have led to
this crisis will some day disappear from the stage and make way
for men whose economic program leads, not to destruction and
chaos, but to economic development and progress.

The Causes of the Economic Crisis: An Address

181

183

I. T

CCEPTANCE OF THE

IRCULATION

REDIT

HEORY OF

USINESS

YCLES

t is frequently claimed that if the causes of cyclical changes
were understood, economic programs suitable for smoothing
out cyclical “waves” would be adopted. The upswing would

then be throttled down in time to soften the decline that
inevitably follows in its wake. As a result, economic development
would proceed at a more even pace. The boom’s accompanying
side effects, considered by many to be undesirable, would then be
substantially, perhaps entirely, eliminated. Most significantly,
however, the losses inflicted by the crisis and by the decline,
which almost everyone deplores, would be considerably reduced,
or even completely avoided.

For many people, this prospect has little appeal. In their opin-

ion, the disadvantages of the depression are not too high a price to
pay for the prosperity of the upswing. They say that not everything

[Mises’s contribution to a Festschrift for Arthur Spiethoff, Die Stellung und
der nächste Zukunft der Konjunkturforschung, pp. 175–80 (Munich:
Duncker and Humblot, 1933). All the contributors were asked to address
themselves to the same topic. Another translation of this article, by Joseph
R. Stromberg, then a doctoral candidate in history at the University of
Florida, appeared in The Libertarian Forum (June 1975). This is a com-
pletely different translation, made by Bettina Bien Greaves and edited by
Percy L. Greaves.—Ed.]

URRENT

TATUS OF

USINESS

YCLE

ESEARCH AND

ROSPECTS FOR THE

MMEDIATE

UTURE

(1933)

produced during the boom period is malinvestment, which must
be liquidated by the crisis. In their opinion, some of the fruits of the
boom remain and the progressing economy cannot do without
them. However, most economists have looked on the elimination
of cyclical changes as both desirable and necessary. Some came to
this position because they thought that, if the economy were
spared the shock of recurring crises every few years, it would help
to preserve the capitalistic system of which they approved. Others
have welcomed the prospect of an age without crises precisely
because they saw—in an economy that was not disturbed by busi-
ness fluctuations—no difficulties in the elimination of the
entrepreneurs who, in their view, were merely the superfluous
beneficiaries of the efforts of others.

Whether these authors looked on the prospect of smoothing

out cyclical waves as favorable or unfavorable, all were of the
opinion that a more thorough examination of the cause of peri-
odic economic changes would help produce an age of less severe
fluctuations. Were they right?

Economic theory cannot answer this question—it is not a the-

oretical problem. It is a problem of economic policy or, more
precisely, of economic history. Although their measures may pro-
duce badly muddled results, the persons responsible for directing
the course of economic policy are better informed today concern-
ing the consequences of an expansion of circulation credit than
were their earlier counterparts, especially those on the European
continent. Yet, the question remains. Will measures be introduced
again in the future which must lead via a boom to a bust?

The Circulation Credit (Monetary) Theory of the Trade Cycle

must be considered the currently prevailing doctrine of cyclical
change. Even persons, who hold another theory, find it necessary
to make concessions to the Circulation Credit Theory. Every sug-
gestion made for counteracting the present economic crisis uses
reasoning developed by the Circulation Credit Theory. Some
insist on rescuing every price from momentary distress, even if
such distress comes in the upswing following a new crisis. To do
this, they would “prime the pump” by further expanding the
quantity of fiduciary media. Others oppose such artificial

184 — The Causes of the Economic Crisis

stimulation, because they want to avoid the illusory credit expan-
sion induced prosperity and the crisis that will inevitably follow.

However, even those who advocate programs to spark and

stimulate a boom recognize, if they are not completely hopeless
dilettantes and ignoramuses, the conclusiveness of the
Circulation Credit Theory’s reasoning. They do not contest the
truth of the Circulation Credit Theory’s objections to their posi-
tion. Instead, they try to ward them off by pointing out that they
propose only a “moderate,” a carefully prescribed “dosage” of
credit expansion or “monetary creation” which, they say, would
merely soften, or bring to a halt, the further decline of prices.
Even the term “re-deflation,”

newly introduced in this connec-

tion with such enthusiasm, implies recognition of the Circulation
Credit Theory. However, there are also fallacies implied in the
use of this term.

II. T

OPULARITY OF

NTEREST

ATES

The credit expansion which evokes the upswing always origi-

nates from the idea that business stagnation must be overcome by
“easy money.” Attempts to demonstrate that this is not the case
have been in vain. If anyone argues that lower interest rates have
not been constantly portrayed as the ideal goal for economic pol-
icy, it can only be due to lack of knowledge concerning economic
history and recent economic literature. Practically no one has
dared to maintain that it would be desirable to have higher inter-
est rates sooner.

People, who sought cheap credit, clamored for

the establishment of credit-issuing banks and for these banks to

The Current Status of Business Cycle Research — 185

[The more modern term for what Mises apparently meant by “re-defla-

tion” is undoubtedly “reflation.”—Ed.]

That has always been so; public opinion has always sided with the

debtors. (See Jeremy Bentham, Defence of Usury, 2nd ed. [London, 1790],
pp. 102ff.). The idea that the creditors are the idle rich, hardhearted
exploiters of workers, and that the debtors are the unfortunate poor, has
not been abandoned even in this age of bonds, bank deposits and savings
accounts.

reduce interest rates. Every measure seized upon to avoid “raising
the discount rate” has had its roots in the concept that credit must
be made “easy.” The fact that reducing interest rates through
credit expansion must lead to price increases has generally been
ignored. However, the cheap money policy would not have been
abandoned even if this had been recognized.

Public opinion is not committed to one single view with

respect to the height of prices as it is in the case of interest rates.
Concerning prices, there have always been two different views:
On the one side, the demand of producers for higher prices and,
on the other side, the demand of consumers for lower prices.
Governments and political parties have championed both
demands, if not at the same time, then shifting from time to time
according to the groups of voters whose favors they court at the
moment. First one slogan, then another is inscribed on their ban-
ners, depending on the temporary shift of prices desired. If prices
are going up, they crusade against the rising cost of living. If
prices are falling, they profess their desire to do everything pos-
sible to assure “reasonable” prices for producers. Still, when it
comes to trying to reduce prices, they generally sponsor pro-
grams which cannot attain that goal. No one wants to adopt the
only effective means—the limitation of circulation credit—
because they do not want to drive interest rates up.

In times of

declining prices, however, they have been more than ready to
adopt credit expansion measures, as this goal is attainable by the
means already desired, i.e., by reducing interest rates.

Today, those who would seek to expand circulation credit

counter objections by explaining that they only want to adjust for
the decline in prices that has already taken place in recent years,
or at least to prevent a further decline in prices. Thus, it is
claimed, such expansion introduces nothing new. Similar argu-
ments were also heard [during the nineteenth century] at the
time of the drive for bimetallism.

186 — The Causes of the Economic Crisis

An extreme example: the discount policy of the German Reichsbank in

the time of inflation. See Frank Graham, Exchange, Prices and Production in
Hyper-Inflation Germany, 1920–1923 (Princeton, N.J., 1930), pp. 65ff.

III. T

OPULARITY OF

ABOR

NION

OLICY

It is generally recognized that the social consequences of

changes in the value of money—apart from the effect such
changes have on the value of monetary obligations—may be
attributed solely to the fact that these changes are not effected
equally and simultaneously with respect to all goods and serv-
ices. That is, not all prices rise to the same extent and at the same
time. Hardly anyone disputes this today. Moreover, it is no longer
denied, as it generally was a few years ago, that the duration of
the present crisis is caused primarily by the fact that wage rates
and certain prices have become inflexible, as a result of union
wage policy and various price support activities. Thus, the rigid
wage rates and prices do not fully participate in the downward
movement of most prices, or do so only after a protracted delay.
In spite of all contradictory political interventions, it is also
admitted that the continuing mass unemployment is a necessary
consequence of the attempts to maintain wage rates above those
that would prevail on the unhampered market. However, in
forming economic policy, the correct inference from this is not
drawn.

Almost all who propose priming the pump through credit

expansion consider it self-evident that money wage rates will not
follow the upward movement of prices until their relative excess
[over the earlier market prices] has disappeared. Inflationary
projects of all kinds are agreed to because no one openly dares to
attack the union wage policy, which is approved by public opin-
ion and promoted by government. Therefore, so long as today’s
prevailing view, concerning the maintenance of higher than
unhampered market wage rates and the interventionist measures
supporting them, exists, there is no reason to assume that money
wage rates can be held steady in a period of rising prices.

IV. T

FFECT OF

OWER THAN

NHAMPERED

ARKET

NTEREST

ATES

The causal connection [between credit expansion and rising

prices] is denied still more intensely if the proposal for limiting

The Current Status of Business Cycle Research — 187

credit expansion is tied in with certain anticipations. If the entre-
preneurs expect low interest rates to continue, they will use the
low interest rates as a basis for their computations. Only then will
entrepreneurs allow themselves to be tempted, by the offer of
more ample and cheaper credit, to consider business enterprises
which would not appear profitable at the higher interest rates
that would prevail on the unaltered loan market.

If it is publicly proclaimed that care will be taken to stop the

creation of additional credit in time, then the hoped-for gains
must fail to appear. No entrepreneur will want to embark on a
new business if it is clear to him in advance that the business can-
not be carried through to completion successfully. The failure of
recent pump-priming attempts and statements of the authorities
responsible for banking policy make it evident that the time of
cheap money will very soon come to an end. If there is talk of
restriction in the future, one cannot continue to “prime the
pump” with credit expansion.

Economists have long known that every expansion of credit

must someday come to an end and that, when the creation of
additional credit stops, this stoppage must cause a sudden change
in business conditions. A glance at the daily and weekly press in
the “boom” years since the middle of the last century shows that
this understanding was by no means limited to a few persons. Still
the speculators, averse to theory as such, did not know it, and they
continued to engage in new enterprises. However, if the govern-
ments were to let it be known that the credit expansion would
continue only a little longer, then its intention to stop expanding
would not be concealed from anyone.

V. T

UESTIONABLE

EAR OF

ECLINING

RICES

People today are inclined to overvalue the significance of

recent accomplishments in clarifying the business cycle problem
and to undervalue the Currency School’s tremendous contribu-
tion. The benefit which practical cyclical policy could derive
from the old Currency School theoreticians has still not been
fully exploited. Modern cyclical theory has contributed little to

188 — The Causes of the Economic Crisis

practical policy that could not have been learned from the
Currency Theory.

Unfortunately, economic theory is weakest precisely where

help is most needed—in analyzing the effects of declining prices.
A general decline in prices has always been considered unfortu-
nate. Yet today, even more than ever before, the rigidity of wage
rates and the costs of many other factors of production hamper
an unbiased consideration of the problem. Therefore, it would
certainly be timely now to investigate thoroughly the effects of
declining money prices and to analyze the widely held idea that
declining prices are incompatible with the increased production
of goods and services and an improvement in general welfare.
The investigation should include a discussion of whether it is true
that only inflationistic steps permit the progressive accumulation
of capital and productive facilities. So long as this naïve inflation-
ist theory of development is firmly held, proposals for using
credit expansion to produce a boom will continue to be success-
ful.

The Currency Theory described some time ago the necessary

connection between credit expansion and the cycle of economic
changes. Its chain of reasoning was only concerned with a credit
expansion limited to one nation. It did not do justice to the situ-
ation, of special importance in our age of attempted cooperation
among the banks of issue, in which all countries expanded
equally. In spite of the Currency Theory’s explanation, the banks
of issue have persistently advised further expansion of credit.

This strong drive on the part of the banks of issue may be

traced back to the prevailing idea that rising prices are useful and
absolutely necessary for “progress” and to the belief that credit
expansion was a suitable method for keeping interest rates low.
The relationship between the issue of fiduciary media and the
formation of interest rates is sufficiently explained today, at least
for the immediate requirements of determining economic policy.
However, what still remains to be explained satisfactorily is the
problem of generally declining prices.

The Current Status of Business Cycle Research — 189

191

he author of this paper is fully aware of its insufficiency.
Yet, there is no means of dealing with the problem of the
trade cycle in a more satisfactory way if one does not

write a treatise embracing all aspects of the capitalist market
economy. The author fully agrees with the dictum of Böhm-
Bawerk: “A theory of the trade cycle, if it is not to be mere
botching, can only be written as the last chapter or the last chap-
ter but one of a treatise dealing with all economic problems.”

It is only with these reservations that the present writer pres-

ents this rough sketch to the members of the Committee.

I. T

NPOPULARITY OF

NTEREST

One of the characteristic features of this age of wars and

destruction is the general attack launched by all governments and
pressure groups against the rights of creditors. The first act of the
Bolshevik Government was to abolish loans and payment of
interest altogether. The most popular of the slogans that swept
the Nazis into power was Brechung der Zinsknechtschaft, abolition
of interest-slavery. The debtor countries are intent upon expro-
priating the claims of foreign creditors by various devices, the
most efficient of which is foreign exchange control. Their eco-
nomic nationalism aims at brushing away an alleged return to

[From a memorandum, dated April 24, 1946, prepared in English by
Professor Mises for a committee of businessmen for whom he served as a
consultant.—Ed.]

RADE

YCLE AND

REDIT

XPANSION

: T

CONOMIC

ONSEQUENCES OF

HEAP

ONEY

(1946)

colonialism. They pretend to wage a new war of independence
against the foreign exploiters as they venture to call those who
provided them with the capital required for the improvement of
their economic conditions. As the foremost creditor nation today
is the United States, this struggle is virtually directed against the
American people. Only the old usages of diplomatic reticence
make it advisable for the economic nationalists to name the devil
they are fighting not the Yankees, but “Wall Street.”

“Wall Street” is no less the target at which the monetary

authorities of this country are directing their blows when
embarking upon an “easy money” policy. It is generally assumed
that measures designed to lower the rate of interest, below the
height at which the unhampered market would fix it, are
extremely beneficial to the immense majority at the expense of a
small minority of capitalists and hardboiled moneylenders. It is
tacitly implied that the creditors are the idle rich while the
debtors are the industrious poor, However, this belief is atavistic
and utterly misjudges contemporary conditions.

In the days of Solon, Athens’s wise legislator, in the time of

ancient Rome’s agrarian laws, in the Middle Ages and even for
some centuries later, one was by and large right in identifying the
creditors with the rich and the debtors with the poor. It is quite
different in our age of bonds and debentures, of savings banks, of
life insurance and social security. The proprietary classes are the
owners of big plants and farms, of common stock, of urban real
estate and, as such, they are very often debtors. The people of
more modest income are bondholders, owners of saving deposits
and insurance policies and beneficiaries of social security. As
such, they are creditors. Their interests are impaired by endeav-
ors to lower the rate of interest and the national currency’s
purchasing power.

It is true that the masses do not think of themselves as credi-

tors and thus sympathize with the noncreditor policies. However,
this ignorance does not alter the fact that the immense majority
of the nation are to be classified as creditors and that these peo-
ple, in approving of an “easy money” policy, unwittingly hurt
their own material interests. It merely explodes the Marxian fable

192 — The Causes of the Economic Crisis

that a social class never errs in recognizing its particular class
interests and always acts in accordance with these interests.

The modern champions of the “easy money” policy take pride

in calling themselves unorthodox and slander their adversaries as
orthodox, old-fashioned and reactionary. One of the most elo-
quent spokesmen of what is called functional finance, Professor
Abba Lerner, pretends that in judging fiscal measures he and his
friends resort to what “is known as the method of science as
opposed to scholasticism.” The truth is that Lord Keynes,
Professor Alvin H. Hansen and Professor Lerner, in their passion-
ate denunciation of interest, are guided by the essence of
Medieval Scholasticism’s economic doctrine, the disapprobation
of interest. While emphatically asserting that a return to the
nineteenth century’s economic policies is out of the question,
they are zealously advocating a revival of the methods of the Dark
Ages and of the orthodoxy of old canons.

II. T

LASSES OF

REDIT

There is no difference between the ultimate objectives of the

anti-interest policies of canon law and the policies recommended
by modern interest-baiting. But the methods applied are differ-
ent. Medieval orthodoxy was intent first upon prohibiting by
decree interest altogether and later upon limiting the height of
interest rates by the so-called usury laws. Modern self-styled
unorthodoxy aims at lowering or even abolishing interest by
means of credit expansion.

Every serious discussion of the problem of credit expansion

must start from the distinction between two classes of credit:
commodity credit and circulation credit.

Commodity credit is the transfer of savings from the hands of

the original saver into those of the entrepreneurs who plan to use
these funds in production. The original saver has saved money by
not consuming what he could have consumed by spending it for
consumption. He transfers purchasing power to the debtor and
thus enables the latter to buy these nonconsumed commodities
for use in further production. Thus the amount of commodity
credit is strictly limited by the amount of saving, i.e., abstention

The Trade Cycle and Credit Expansion — 193

from consumption. Additional credit can only be granted to the
extent that additional savings have been accumulated. The whole
process does not affect the purchasing power of the monetary
unit.

Circulation credit is credit granted out of funds especially cre-

ated for this purpose by the banks. In order to grant a loan, the
bank prints banknotes or credits the debtor on a deposit account.
It is creation of credit out of nothing. It is tantamount to the cre-
ation of fiat money, to undisguised, manifest inflation. It
increases the amount of money substitutes, of things which are
taken and spent by the public in the same way in which they deal
with money proper. It increases the buying power of the debtors.
The debtors enter the market of factors of production with an
additional demand, which would not have existed except for the
creation of such banknotes and deposits. This additional demand
brings about a general tendency toward a rise in commodity
prices and wage rates.

While the quantity of commodity credit is rigidly fixed by the

amount of capital accumulated by previous saving, the quantity
of circulation credit depends on the conduct of the bank’s busi-
ness. Commodity credit cannot be expanded, but circulation
credit can. Where there is no circulation credit, a bank can only
increase its lending to the extent that the savers have entrusted it
with more deposits. Where there is circulation credit, a bank can
expand its lending by what is, curiously enough, called “being
more liberal.”

Credit expansion not only brings about an inextricable ten-

dency for commodity prices and wage rates to rise it also affects
the market rate of interest. As it represents an additional quan-
tity of money offered for loans, it generates a tendency for
interest rates to drop below the height they would have reached
on a loan market not manipulated by credit expansion. It owes its
popularity with quacks and cranks not only to the inflationary
rise in prices and wage rates which it engenders, but no less to its
short-run effect of lowering interest rates. It is today the main
tool of policies aiming at cheap or easy money.

194 — The Causes of the Economic Crisis

III. T

UNCTION OF

RICES

, W

AGE

ATES

AND

NTEREST

ATES

The rate of interest is a market phenomenon. In the market

economy it is the structure of prices, wage rates and interest
rates, as determined by the market, that directs the activities of
the entrepreneurs toward those lines in which they satisfy the
wants of the consumers in the best possible and cheapest way.
The prices of the material factors of production, wage rates and
interest rates on the one hand and the anticipated future prices of
the consumers’ goods on the other hand are the items that enter
into the planning businessman’s calculations. The result of these
calculations shows the businessman whether or not a definite
project will pay. If the market data underlying his calculations are
falsified by the interference of the government, the result must be
misleading. Deluded by an arithmetical operation with illusory
figures, the entrepreneurs embark upon the realization of proj-
ects that are at variance with the most urgent desires of
consumers. The disagreement of the consumers becomes mani-
fest when the products of capital malinvestment reach the
market and cannot be sold at satisfactory prices. Then, there
appears what is called “bad business.”

If, on a market not hampered by government tampering with

the market data, the examination of a definite project shows its
unprofitability, it is proved that under the given state of affairs the
consumers prefer the execution of other projects. The fact that a
definite business venture is not profitable means that the con-
sumers, in buying its products, are not ready to reimburse
entrepreneurs for the prices of the complementary factors of pro-
duction required, while on the other hand, in buying other
products, they are ready to reimburse entrepreneurs for the prices
of the same factors. Thus the sovereign consumers express their
wishes and force business to adjust its activities to the satisfaction
of those wants which they consider the most urgent. The con-
sumers thus bring about a tendency for profitable industries to
expand and for unprofitable ones to shrink.

The Trade Cycle and Credit Expansion — 195

It is permissible to say that what proximately prevents the exe-

cution of certain projects is the state of prices, wage rates and
interest rates. It is a serious blunder to believe that if only these
items were lower, production activities could be expanded. What
limits the size of production is the scarcity of the factors of pro-
duction. Prices, wage rates and interest rates are only indices
expressive of the degree of this scarcity. They are pointers, as it
were. Through these market phenomena, society sends out a
warning to the entrepreneurs planning a definite project: Don’t
touch this factor of production; it is earmarked for the satisfac-
tion of another, more urgent need.

The expansionists, as the champions of inflation style them-

selves today, see in the rate of interest nothing but an obstacle to
the expansion of production. If they were consistent, they would
have to look in the same way at the prices of the material factors of
production and at wage rates. A government decree cutting down
wage rates to 50 percent of those on the unhampered labor market
would likewise give to certain projects, which do not appear prof-
itable in a calculation based on the actual market data, the
appearance of profitability. There is no more sense in the assertion
that the height of interest rates prevents a further expansion of
production than in the assertion that the height of wage rates
brings about these effects. The fact that the expansionists apply
this kind of fallacious argumentation only to interest rates and not
also to the prices of primary commodities and to the prices of labor
is the proof that they are guided by emotions and passions and not
by cool reasoning. They are driven by resentment. They envy what
they believe is the rich man’s take. They are unaware of the fact that
in attacking interest they are attacking the broad masses of savers,
bondholders and beneficiaries of insurance policies.

IV. T

FFECTS OF

OLITICALLY

OWERED

NTEREST

ATES

The expansionists are quite right in asserting that credit

expansion succeeds in bringing about booming business. They
are mistaken only in ignoring the fact that such an artificial
prosperity cannot last and must inextricably lead to a slump, a
general depression.

196 — The Causes of the Economic Crisis

If the market rate of interest is reduced by credit expansion,

many projects which were previously deemed unprofitable get
the appearance of profitability. The entrepreneur who embarks
upon their execution must, however, very soon discover that his
calculation was based on erroneous assumptions. He has reck-
oned with those prices of the factors of production which
corresponded to market conditions as they were on the eve of the
credit expansion. But now, as a result of credit expansion, these
prices have risen. The project no longer appears so promising as
before. The businessman’s funds are not sufficient for the pur-
chase of the required factors of production. He would be forced
to discontinue the pursuit of his plans if the credit expansion
were not to continue. However, as the banks do not stop expand-
ing credit and providing business with “easy money,” the
entrepreneurs see no cause to worry. They borrow more and
more. Prices and wage rates boom. Everybody feels happy and is
convinced that now finally mankind has overcome forever the
gloomy state of scarcity and reached everlasting prosperity.

In fact, all this amazing wealth is fragile, a castle built on the

sands of illusion. It cannot last. There is no means to substitute
banknotes and deposits for nonexisting capital goods. Lord
Keynes, in a poetical mood, asserted that credit expansion has
performed “the miracle . . . of turning a stone into bread.”

But

this miracle, on closer examination, appears no less questionable
than the tricks of Indian fakirs.

There are only two alternatives.

One, the expanding banks may stubbornly cling to their expan-

sionist policies and never stop providing the money business
needs in order to go on in spite of the inflationary rise in produc-
tion costs. They are intent upon satisfying the ever increasing
demand for credit. The more credit business demands, the more
it gets. Prices and wage rates sky-rocket. The quantity of bank-
notes and deposits increases beyond all measure. Finally, the
public becomes aware of what is happening. People realize that

Paper of the British Experts (April 8, 1943).

The Trade Cycle and Credit Expansion — 197

there will be no end to the issue of more and more money substi-
tutes—that prices will consequently rise at an accelerated pace.
They comprehend that under such a state of affairs it is detrimen-
tal to keep cash. In order to prevent being victimized by the
progressing drop in money’s purchasing power, they rush to buy
commodities, no matter what their prices may be and whether or
not they need them. They prefer everything else to money. They
arrange what in 1923 in Germany, when the Reich set the classi-
cal example for the policy of endless credit expansion, was called
die Flucht in die Sachwerte, the flight into real values. The whole
currency system breaks down. Its unit’s purchasing power dwin-
dles to zero. People resort to barter or to the use of another type
of foreign or domestic money. The crisis emerges.

The other alternative is that the banks or the monetary

authorities become aware of the dangers involved in endless
credit expansion before the common man does. They stop, of
their own accord, any further addition to the quantity of bank-
notes and deposits. They no longer satisfy the business
applications for additional credits. Then the panic breaks out.
Interest rates jump to an excessive level, because many firms
badly need money in order to avoid bankruptcy. Prices drop sud-
denly, as distressed firms try to obtain cash by throwing
inventories on the market dirt cheap. Production activities
shrink, workers are discharged.

Thus, credit expansion unavoidably results in the economic

crisis. In either of the two alternatives, the artificial boom is
doomed. In the long run, it must collapse. The short-run effect,
the period of prosperity, may last sometimes several years. While
it lasts, the authorities, the expanding banks and their public rela-
tions agencies arrogantly defy the warnings of the economists
and pride themselves on the manifest success of their policies.
But when the bitter end comes, they wash their hands of it.

The artificial prosperity cannot last because the lowering of the

rate of interest, purely technical as it was and not corresponding
to the real state of the market data, has misled entrepreneurial
calculations. It has created the illusion that certain projects offer
the chances of profitability when, in fact, the available supply of

198 — The Causes of the Economic Crisis

factors of production was not sufficient for their execution.
Deluded by false reckoning, businessmen have expanded their
activities beyond the limits drawn by the state of society’s wealth.
They have underrated the degree of the scarcity of factors of pro-
duction and overtaxed their capacity to produce. In short: they
have squandered scarce capital goods by malinvestment.

The whole entrepreneurial class is, as it were, in the position

of a master builder whose task it is to construct a building out of
a limited supply of building materials. If this man overestimates
the quantity of the available supply, he drafts a plan for the exe-
cution of which the means at his disposal are not sufficient. He
overbuilds the groundwork and the foundations and discovers
only later, in the progress of the construction, that he lacks the
material needed for the completion of the structure. This belated
discovery does not create our master builder’s plight. It merely
discloses errors committed in the past. It brushes away illusions
and forces him to face stark reality.

There is need to stress this point, because the public, always in

search of a scapegoat, is as a rule ready to blame the monetary
authorities and the banks for the outbreak of the crisis. They are
guilty, it is asserted, because in stopping the further expansion of
credit, they have produced a deflationary pressure on trade. Now,
the monetary authorities and the banks were certainly responsi-
ble for the orgies of credit expansion and the resulting boom;
although public opinion, which always approves such inflation-
ary ventures wholeheartedly, should not forget that the fault rests
not alone with others. The crisis is not an outgrowth of the aban-
donment of the expansionist policy. It is the inextricable and
unavoidable aftermath of this policy. The question is only
whether one should continue expansionism until the final col-
lapse of the whole monetary and credit system or whether one
should stop at an earlier date. The sooner one stops, the less
grievous are the damages inflicted and the losses suffered.

Public opinion is utterly wrong in its appraisal of the phases of

the trade cycle. The artificial boom is not prosperity, but the
deceptive appearance of good business. Its illusions lead people
astray and cause malinvestment and the consumption of unreal

The Trade Cycle and Credit Expansion — 199

200 — The Causes of the Economic Crisis

apparent gains which amount to virtual consumption of capital.
The depression is the necessary process of readjusting the
structure of business activities to the real state of the market data,
i.e., the supply of capital goods and the valuations of the public.
The depression is thus the first step on the return to normal con-
ditions, the beginning of recovery and the foundation of real
prosperity based on the solid production of goods and not on the
sands of credit expansion.

Additional credit is sound in the market economy only to the

extent that it is evoked by an increase in the public’s savings and
the resulting increase in the amount of commodity credit. Then,
it is the public’s conduct that provides the means needed for
additional investment. If the public does not provide these
means, they cannot be conjured up by the magic of banking
tricks. The rate of interest, as it is determined on a loan market
not manipulated by an “easy money” policy, is expressive of the
people’s readiness to withhold from current consumption a part
of the income really earned and to devote it to a further expan-
sion of business. It provides the businessman reliable guidance
in determining how far he may go in expanding investment,
what projects are in compliance with the true size of saving and
capital accumulation and what are not. The policy of artificially
lowering the rate of interest below its potential market height
seduces the entrepreneurs to embark upon certain projects of
which the public does not approve. In the market economy, each
member of society has his share in determining the amount of
additional investment. There is no means of fooling the public
all of the time by tampering with the rate of interest. Sooner or
later, the public’s disapproval of a policy of over-expansion takes
effect. Then the airy structure of the artificial prosperity col-
lapses.

Interest is not a product of the machinations of rugged

exploiters. The discount of future goods as against present goods
is an eternal category of human action and cannot be abolished
by bureaucratic measures. As long as there are people who prefer
one apple available today to two apples available in twenty-five
years, there will be interest. It does not matter whether society is

organized on the basis of private ownership of the means of pro-
duction, viz., capitalism, or on the basis of public ownership, viz.,
socialism or communism. For the conduct of affairs by a
totalitarian government, interest, the different valuation of present
and of future goods, plays the same role it plays under capitalism.

Of course, in a socialist economy, the people are deprived of

any means to make their own value judgments prevail and only
the government’s value judgments count. A dictator does not
bother whether or not the masses approve of his decision of how
much to devote for current consumption and how much for addi-
tional investment. If the dictator invests more and thus curtails
the means available for current consumption, the people must
eat less and hold their tongues. No crisis emerges, because the
subjects have no opportunity to utter their dissatisfaction. But in
the market economy, with its economic democracy, the con-
sumers are supreme. Their buying or abstention from buying
creates entrepreneurial profit or loss. It is the ultimate yardstick
of business activities.

V. T

NEVITABLE

NDING

It is essential to realize that what makes the economic crisis

emerge is the public’s disapproval of the expansionist ventures
made possible by the manipulation of the rate of interest. The
collapse of the house of cards is a manifestation of the democratic
process of the market.

It is vain to object that the public favors the policy of cheap

money. The masses are misled by the assertions of the pseudo-
experts that cheap money can make them prosperous at no
expense whatever. They do not realize that investment can be
expanded only to the extent that more capital is accumulated by
savings. They are deceived by the fairy tales of monetary cranks
from John Law down to Major C.H. Douglas. Yet, what counts in
reality is not fairy tales, but people’s conduct. If men are not pre-
pared to save more by cutting down their current consumption,
the means for a substantial expansion of investment are lacking.

The Trade Cycle and Credit Expansion — 201

202 — The Causes of the Economic Crisis

These means cannot be provided by printing banknotes or by
loans on the bank books.

In discussing the situation as it developed under the expan-

sionist pressure on trade created by years of cheap interest rates
policy, one must be fully aware of the fact that the termination of
this policy will make visible the havoc it has spread. The incorri-
gible inflationists will cry out against alleged deflation and will
advertise again their patent medicine, inflation, rebaptizing it
re-deflation.

What generates the evils is the expansionist policy.

Its termination only makes the evils visible. This termination
must at any rate come sooner or later, and the later it comes, the
more severe are the damages which the artificial boom has
caused. As things are now, after a long period of artificially low
interest rates, the question is not how to avoid the hardships of
the process of recovery altogether, but how to reduce them to a
minimum. If one does not terminate the expansionist policy in
time by a return to balanced budgets, by abstaining from govern-
ment borrowing from the commercial banks and by letting the
market determine the height of interest rates, one chooses the
German way of 1923.

[See note on p. 185, note 1.—Ed.]

Agriculture, 102, 165, 173–74
American Revolution, 11, 22
“Anarchy” of production, 155–56
Apoplithorismosphobia, 60–61, 72
Aristophanes, 50
Austria (Austro-Hungarian Empire), 6,

21, 33, 118–19, 130n, 141, 150n
money and banking policy of, 66

Austrian School of economics, 54

See also Circulation Credit (Mone-

tary) Theory

Autarky, 174
Averages (arithmetical means), in deter-

mining index numbers, 77–78

Balance-of-payments, doctrine of foreign

exchange, 25–31, 44–51

Banknotes, prohibition against, not cov-

ered by metal, 39ff.

Banking policy

history of, 62–66, 116–23, 132–34,

140–46

“needs of business” doctrine, 103–05,

121–23

See also Free banking; Germany;

Monetary reform; United States

Banking School, 42, 44, 54, 66, 103–05,

122, 130

Banks, government intervention in,

125–26

Bastiat, Frédéric, 133
Bendixen, Friedrich, 42
Bills of exchange, xvi, 105
Bimetallism, 61, 94
Böhm-Bawerk, Eugen von, 56, 191
Bourse, 4n
Business cycles. See Trade cycles

Business forecasting (speculation), 7–8,

146–49, 195–96

Cantillon effect (injection effect), 85ff.
Capitalism, 35
Capitalistic (market) production, 34–35,

155–60, 171–72, 199

Cassell, Gustav, 72
Chartism, 58n, 20
Circulation Credit (Monetary) Theory of

the Trade Cycle, xvii, 53, 101–15,
119–26, 132–40, 149–53, 160–63,
183–85, 189

Classical economics and value theory, 54
Classical liberalism. See Liberals (liberal-

ism)

Coefficient of importance, in computing

index numbers, 78–79

Commodity bills. See Bills of exchange
Commodity money, 62n
Commodity prices, 172–73
Consumers, 156–58
Continentals, 11, 22
Credit expansion, halting the, 14
Credit expansion, xix, 104, 162

course of business cycle and, 85–88,

105–15, 119, 127–28, 160–62,
195–202

creditor-debtor relations and, 88–93
crisis and, 113–15, 118n, 127, 155–83
demand for, 121–23, 125–26, 132–34,

183–88

interest rates and, 107–09, 140–46,

195–202

See also Circulation Credit (Mone-

tary) Theory; Currency School;
Malinvestment

203

NDEX

Credit money, 61, 81
Credit, commodity versus circulation,

xix, 104–05, 193–94

Currency profits and losses, 23
Currency School, 25–26, 44, 49, 53, 66,

97–99, 101, 108, 122–23, 126,
128–29, 132–34, 149–50

Deficit financing, 35–39
Deflation (deflationism), xv, 30, 60–61, 72

as check against demand for foreign

exchange, 30

Democracy, economic, 158
Demonetization, 3
Douglass, William, 122

Easy money, 139, 185, 197

See also Credit expansion

Economic crisis. See Credit expansion
Economic measurement. See Index num-

bers; Statistical studies

Economic thought

history of, 53–56
See also Banking School; Circulation

Credit (Monetary) Theory; Cur-
rency School; Quantity Theory

Empirical studies, 135–36
England, monetary policy of, 33, 68,

125–26, 129, 150

Entrepreneur, role of, 157–60
Exports, monetary depreciation and,

86–87

Federal Reserve System. See United

States

Fiduciary media, 103, 125

defined, 62

Final state of rest, 72
Fisher, Irving, 59, 82ff., 87–88, 96
Fisher’s Plan, 59, 82ff., 87–88, 96
Flexible standard. See Gold exchange

(flexible) standard

Flight to real values. See Inflation
“Forced savings.” See Savings, “forced”
Forecasting, 146ff.
Foreign exchange rates, and war, 21ff.
Foreign exchange, rate, “final” (“natural”

204 — The Causes of the Economic Crisis

or “static”), 24, 26, 31
rate, explained by balance-of-pay-

ments, 46

speculation, 5, 9–12, 14–18, 23–24,

26–31, 35–36

France, 117
Free banking, xvii, 15n, 124–25, 130, 140

See also Banking policy; Monetary
reform

French Revolution, and inflation, 11, 22

Germany

money and banking policy of, xv, 3, 5,

10, 12, 14–17, 21, 22, 31–38,
40–42, 60, 66, 68, 79, 83–84, 117,
121, 123

science and ideology of, 47, 54–55
Treaty of Versailles and reparations

and, 5n, 34–38

value of currency against gold, 16, 23

Giro banking system, 40
Gold (coin or “pure”) standard, 2, 18–20,

20n, 41n, 49–50, 60–61, 67–73,
93–95, 152
definition of, 23
manipulation of, 69ff.

Gold exchange (flexible) standard,

18–20, 40, 62–66
confidence in the new money under,

Gold outflow (capital flight), 25–26,

48–49

Gold premium policy, 41, 141
Gold

costs and benefits of, 63
demand for, 62
supply and production, 18, 19, 60–68,

72, 96, 134, 176–79

value of, 67, 71ff.

Gossen, Hermann Heinrich, 54, 85n
Government intervention, 169–70

in international monetary move-

ments, 25

Gregory, T.E., 28n
Gresham’s Law, 2, 25–26, 50, 94

Haberler, Gottfried, 76n
Hansen, Alvin H., 193

Index — 205

Harvard Three Market Barometer, 135–37
Hayek, Friedrich A., xi
Helfferich, Karl, 34
Historicism (Historical-Empirical-Realis-

tic School), 66, 98

Hoarding, prohibition of, of foreign

moneys, 30

Hume, David, 7
Hungary, 8, 17
Hyperinflation

collapse of paper monetary system

under, 30

See also Inflation

Ideology, 146

influence of, 43–44, 121, 123–27, 131,

138–39, 174–76, 179–81

Imaginary construction, 73–76
Immigration, 170
Index numbers, 57–60, 77–79, 80–88
Index standard, 58, 96
Inflation

arguments for, xviii, 31–33
as a kind of a tax, 32
as creating illusory prosperity, 33
as a product of human action, 38, 43
as a psychological aid to economic

policy, 33, 38

as a remedy against overly high wage

rates, 178

course of, 2–13, 16–18, 44–45, 85–88,

117–18, 162, 198

crack-up boom (crisis and panic),

7–14, 114

creditor-debtor relations under, 7–9,

88–94

defined, 2n
disrupts business calculations, 6–8, 33
“flight to real values,” 8–9, 114,

162–63

foreign exchange and, 36, 45
international trade and, 21–24,

25–31, 44–51, 87

paper money, 117
shift to foreign money and specie

under, 10–11

speculation under, 9–10

Inflationism, as a lesser evil, 31–32

Institutionalism, 54
Interest rates

demand for lower, 121–23, 160–63
effects of inflation on, 7–8
effect of credit expansion on, 7,

107–08, 142–44, 185–88, 196–202

gross, 83
influence of banks and government

on, 104–05, 136–38, 191–93,
196–202

natural rate versus money rate,

107–15, 120, 163

price premium, xv, 82–84, 109–15,

134

market (“natural” or “static”), 161,

195–96

International cooperation, 140–42, 152
Interventionism, xvii–xviii, 127, 180

See also Government intervention

Italy, 117

Jevons, William Stanley, 54, 58n
Justice, 89

Keynes, John Maynard, xviii, 59, 96, 152,

193, 197

Knapp, Georg Friedrich, 12n
Kondratieff, N.D., 117n

Labor, 157–58, 164–69, 178–79, 187,

195–96. See also Wages; Unemploy-
ment

Legal tender laws, 11
Lerner, Abba, 193
Liberals (liberalism), 68, 93–94
Lowe, Joseph, 58

Machlup, Fritz, 64n
Malinvestment, xvi, 109–11, 114–15,

142, 160–63, 178, 196–201

Mandats, 11, 22
Marks, 10
Marxian doctrines, 100, 155–56
Measurement. See Index numbers;

Money; Statistical studies

Menger, Carl, 54, 76n

Mercantilism, 48

neo-, 30

Modern economy, greater importance of

money to, 12

Monetary depreciation (appreciation), 3,

15, 36, 43, 106, 110, 152

Monetary manipulation, 57–60, 80–82,

88–93, 140–46
See also Gold standard

Monetary reform, 14–24, 39–44,

138–40, 149–50, 179–81

Monetary standard, subsidiary versus

vassal, 19

Monetary theory of the trade cycle. See

Circulation Credit (Monetary) The-
ory of the Trade Cycle

Monetary unit

purchasing power of, xiv, 2–7, 22–24,

26–31, 68–76, 88–93, 105–07,
116–17, 133–34

purchasing power of, measuring, 73ff.

Monetary value, in the short run, 23
Money (money substitutes), 57, 61–62,

103–05, 128
as standard of deferred payments, 58

demand for, 2–6, 8–9, 62n, 103

external exchange value of, 1n, 76n
internal objective exchange value of,

1n, 76n

market, 41–42, 140–45
“scarcity of,” 7, 42
shortage of notes of, 6, supply of, 18,

subjective exchange valuation of, 74
treated as capital stock, 21
See also Stabilization of prices; State

Theory of Money

Monometallism. See Gold standard; Sil-

ver standard

Multiple commodity standard, 58–60,

81–82, 90

Natural versus money interest rates. See

Interest rates

Necessities versus luxuries, 28
Needs of business, 103–05, 121–23,

127–28

Nominalism, 54, 58n

206 — The Causes of the Economic Crisis

Overproduction theory of the trade

cycle, 100

Overstone, Lord Samuel Jones Loyd, 53,

98, 119, 131

Paper money. See Credit money
Parity, between paper and commodity

moneys, 93

Peel’s Bank Act (1844), 39, 44, 55, 112n,

126, 134

Pessimism, 99
Poland, 17
Post office savings institution, 150
Price level fallacy, 74, 151–52

See also Index numbers

Price premium. See Interest rates
Price supports and subsidies, 172–73
Prices, 88–93, 155–60, 195–96

as indices of scarcity, 196

Producers’ policy, 159–60
Proudhon, Pierre Jean, 133
Psychological and intellectual theories of

the trade cycle, 100–01

Pump-priming, 184
Purchasing power parity, 26, 45–46

Quantity theory of money, 4, 25, 53, 57,

81, 133

Rathenau, Walter, 37n
“Rationalization,” 159, 171
Re-deflation, 185, 202
Reparations, war, 34ff.
Reserves, interest on “idle,” 65ff.
Ricardo, David, 20, 53, 63
Romanovs, 8n
Röpke, Wilhelm, 117n
Russia, 8n

Savings, “forced” (“compulsory”), 106,

111–13, 128, 129

Schaefer, Carl A., 19n
Scrope, G. Poulett, 58
Seipel, Ignaz, 6n
Seisachtheia, 93
Silver standard, 61

Index — 207

Smith, Adam, 7, 63, 121
Speculation, 17, 143
Spencer, Herbert, 148
Spiethoff, Arthur, xviii
Stabilization crisis, 118
Stabilization of prices (monetary value),

55, 57, 72, 80–91, 97, 151–52,
172–74, 176–78

State Theory of Money, 12n, 58n, 69, 79
Stationary economy, 91, 97
Statist Theory, 43–44

See also Government intervention

Statistical studies, xvi, 73–79, 135–36,

146–49

Stock market, 144–45
Subjective value theory, 54
Suess, Eduard, 72

Tabular standard, 58ff

See also Multiple commodity stan-

dard

Taxation, 175–76

as check against demand for foreign

exchange, 32–38

as affecting the entire economy, 32
public opinion and, 37

Terminology, 76n, 103n
Theirs, Louis Adolphe, 11
Time preference, 200
Tooke, Thomas, 123

Trade cycle theories, 99–103, 119–21,

160
See also Circulation Credit (Mone-

tary) Theory of the Trade Cycle;
Credit expansion

Trade cycles, 56, 97ff.
Translations, xix

Underconsumption theory of the trade

cycle, 100

Unemployment, 164–72
Unions, labor, xviii, 166, 187
United States, agriculture of, 102,

173–74
Federal Reserve System of, 70, 126,

132

monetary policy of, 125–26, 150

Vaihinger, Hans, 74

Wages, 165
Walras, Leon, 54, 132
Weather theory of the trade cycle, 100
White, Horace, 11
Wicksell, Knut, 107, 132
World War I, 69, 86

Document Outline

Title page
Contents
Foreword
Introduction
1.Stabilization of the Monetary Unit
2.Monetary Stabilization and Cyclical Policy
- Part A.Stabilization of the Purchasing Power of the Monetary Unit
- Part B. Cyclical Policy to Eliminate Economic Fluctuations
3.The Causes of the Economic Crisis: An Address (1931)
4.The Current Status of Business Cycle Research and Its Prospects for the Immediate Future (1933)
5.The Trade Cycle and Credit Expansion
Index

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